Health Net, Inc. (HNT) Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.25.13 | About: Health Net, (HNT)

Health Net, Inc. (NYSE:HNT)

Q2 2013 Earnings Call

July 25, 2013 11:00 am ET

Executives

Angie McCabe - Vice President of Investor Relations

Jay M. Gellert - Chief Executive Officer, President and Director

Analysts

Joshua R. Raskin - Barclays Capital, Research Division

Sarah James - Wedbush Securities Inc., Research Division

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Justin Lake - JP Morgan Chase & Co, Research Division

Ralph Giacobbe - Crédit Suisse AG, Research Division

Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

David H. Windley - Jefferies LLC, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Ana Gupte - Dowling & Partners Securities, LLC

Christine Arnold - Cowen and Company, LLC, Research Division

Brian Turner

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

Carl R. McDonald - Citigroup Inc, Research Division

Operator

Good morning, everyone, and welcome the Health Net, Inc., Second Quarter 2013 Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to Angie McCabe, Vice President of Investor Relations. Please go ahead.

Angie McCabe

Thank you, Kyle, and thank you all for joining us for a discussion of Health Net's second quarter 2013 results.

During this call, we will make forward-looking statements that are subject to certain risks and uncertainties. Risk factors that may impact those statements and could cause actual future results to differ materially from currently expected results are described in our filings with the SEC as well as the cautionary statements in our press release issued in advance of this call.

In today's call, we will refer to adjusted days claims payable. This adjusted metric is not being presented in accordance with Generally Accepted Accounting Principles, or GAAP. Please refer to today's press release, which is available on the company's website, for a reconciliation of this non-GAAP financial measure with the most directly comparable GAAP financial measure, days claims payable.

I will now turn the call over to Jay Gellert, Health Net CEO. Jay?

Jay M. Gellert

Thank you, Angie, and good morning. I'm pleased to report on our continuing strong operating performance in 2013 and our preparations for our key new business opportunities next year. In the second quarter of '13, each line of business improved sequentially, helped by ongoing favorable health care cost trends. Commercial, Medicare and Medicaid improved quarter-over-quarter. We expect to sustain our current performance in the second half of 2013.

Our strong operating performance gives us the flexibility to make necessary investments in our future. These investments include preparing for: One, the exchanges; two, the California Coordinated Care Initiative, which includes the dual demonstration; three, Medicaid expansion from the ACA; and four, our entry into Arizona Medicaid. These investments and the impact of reinstated Medicaid premium taxes caused us to raise our G&A guidance. I'll cover that in more detail in a few moments.

We are adjusting our GAAP earnings per diluted share guidance to $2.10 to $2.20 to reflect the second quarter severance costs. Our full year combined Western Region and Government Contracts EPS guidance of $2.20 to $2.30 exists despite the higher G&A expenses.

Let's now look at the second quarter highlights.

I want to first speak about the improvement in our commercial book. Last year, we laid out a very clear plan to reposition the commercial book away from unprofitable, full-network, large-group accounts to smaller accounts and tailored network products. We believed that this plan would improve the MCR. The plan is working and produced the intended improvement. In the second quarter of 2013, the commercial MCR was 84.9%, 380 basis points better than the second quarter of 2012 and 100 basis points better than the commercial MCR in the first quarter of 2013. Recall that we did have adverse prior-period development in 2012 second quarter. In the second quarter of 2013, we had no adverse prior-period development.

The premium yield-to-health care cost spread was positive 430 basis points in the second quarter of this year after being negative a year ago. Given the wealth of 2014 opportunities we have, we continue to price in a disciplined manner. With this in mind, we are maintaining our commercial premium yield-to-health care cost spread guidance for the balance of '13.

As part of the effort to reposition the commercial book, we did anticipate membership attrition. Commercial enrollment has declined by approximately 8% year-to-date within our overall guidance range for the full year of 2013.

The key to our commercial enrollment story continues to be our tailored network products. At the end of the second quarter of '13, our tailored network products account for more than 37% of total commercial enrollment, up from approximately 35% at the end of the second quarter of '12. Our tailored network momentum got a new boost in the second quarter as CalPERS selected Health Net's tailored network products as part of its offering to members in '14. We are seeing more interest in tailored network products in the large accounts segment, where such products have not historically been a significant factor.

Let me make a brief comment about our Government Contracts segment. We noted when we announced our first quarter '13 results that we expected significant improvement in the pretax contribution in the second quarter of '13. That's what happened as Government Contracts contributed approximately $18.1 million in pretax income in the second quarter. We now expect the full year pretax income for 2013 to be approximately $55 million to $60 million, somewhat lower than prior guidance due to certain adjustments under our TRICARE contract.

Let me now turn to Medicare. The Medicare Advantage MCR did well in the second quarter of '13. It improved by 210 basis points compared with the second quarter of '12. We're encouraged by the favorable Medicare health care cost trends, particularly in physician and outpatient services. We expect the Medicare Advantage MCR to be close to this level or even better through the second half of '13.

Let me make a brief comment on our MA proposals for next year. We approached '14 in much the same way that we approached '13. We focused on achieving reasonable margins and gaining enrollment in specific geographic areas where we have more competitive health care cost structures.

Medicaid did well in the second quarter of '13, as moderating health care costs contributed to MCR improvement quarter-over-quarter. This sequential Medicaid MCR improvement was significantly influenced by California's reinstatement of Medicaid premium taxes on June 27 as part of the new state budget. The taxes were retroactive to July 1, '12. This resulted in our recording $35.7 million in premium tax expense on the G&A line in the second quarter of '13. In addition, the state increased premiums by the same amount, so there's no impact on the bottom line. The increased premiums, though, did benefit the Medicaid MCR by 510 basis points in the second quarter of '13. The Medicaid premium tax effect caused the G&A ratio to be higher in the second quarter, at 11%. The $35.7 million in premium taxes amounted to approximately 120 basis points. We currently expect taxes to continue for 3 years starting July 1, '13.

We've revised our G&A guidance for the full year of '13 to between 10% and 10.5% due to several factors. One, the $70 million in incurred and expected Medicaid tax expense for '13. The tax rate will increase in the third and fourth quarter of '13 to 3.94% from the 2.35% for the 12 months ended June 30, 2013.

Two, we expect approximately $20 million of expenses to prepare for the CCI implementation, expenses which we have previously excluded from guidance. So far, we've spent approximately $7.4 million in the first half on CCI.

Three, we also will see higher spending of approximately $10 million to prepare for the new CalPERS enrollment, Arizona Medicaid and Medicaid expansion.

Just to reiterate, our 2013 G&A guidance still includes approximately $30 million of expense to prepare for the individual health insurance exchanges and other facets of health care reform. We've spent approximately $10 million in the first half on these matters.

Three other items of revised guidance bear mentioning: We're adjusting our tax rate guidance to 38% to 38.5% for '13; we're modifying investment income guidance to approximately $70 million for the full year, as interest rate increases have reduced the opportunity to achieve realized gains in the second half of this year; and, we are now giving you a range of fully diluted shares outstanding of 80 million to 81 million for the full year calculation. We are being prudent with our approach to capital given our multiple new business opportunities.

Let me add some additional thoughts about the future. We have received initial information about our new California Medicaid rates that take effect on October 1, 2013. We believe the new rates adequately reflect underlying health care costs in the traditional Medicaid and SPD populations. In so doing, we believe these rates will allow us to achieve the targeted performance included in our risk-sharing agreement.

Turning now to the opportunities created by health care reform. On May 23, Covered California, the new insurance individual exchange, selected Health Net for 13 regions, 8 in Southern California. For the individual exchanges, we based our HMO offering on the tailored network chassis that's worked so well in small group for the past several years. We've also been selected for the individual exchange in Oregon. We expect Medicaid expansion in California and, as one of the state's leading Medicaid plans, we intend to be a significant participant in that expansion.

We're also pleased that we are about to enter the Arizona Medicaid market in the fourth quarter of '13. We'll likely start with just a few thousand members but expect enrollment will build over time, helped by the state's expansion plans. This is an important step in our Arizona progress. We've also seen encouraging signs across the board in our Arizona health plan in the second quarter of '13.

Last, of course, are the dual-eligible demonstrations in Los Angeles and San Diego County. We continue to make the necessary preparations so we'll be ready for implementation early next year. We recently participated in a readiness review and are encouraged by the opportunity to improve quality, access and cost effectiveness for this vulnerable population. We continue to work with the state and CMS to reach agreement regarding final rates.

Let me close with a comment about scale. We continue to explore a range of options that could lead to significant G&A savings over time. While this effort is ongoing, we are also taking steps to reduce G&A where feasible, as we did in the second quarter. We eliminated certain positions, largely in Government Contracts, a reflection of the impact of sequestration, and in other areas, as we are streamlining our management structure to better address our future opportunities. These changes led to the severance charge we incurred in the second quarter.

Thank you for the time this morning to discuss the second quarter and our outlook. We believe we have much to look forward to and are excited about the new horizons we have before us. We are now ready for Q&A.

Angie McCabe

Kyle, could you please open the lines.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Joshua Raskin from Barclays.

Joshua R. Raskin - Barclays Capital, Research Division

Jay, so I just want to make sure I understand the incremental costs that are being absorbed in guidance that were previously not. I think last quarter you talked about $30 million in PPACA and exchanges. It sounds like that's unchanged. It sounds like there's an incremental $10 million that is new and that's the CalPERS preparation, the Arizona Medicaid and then PPACA. I guess that's separate from the other PPACA, but that's Medicaid expansion, right?

Jay M. Gellert

Yes.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. The $20 million of the CCI cost, how much of that is actually Health Net incurred and not part of the agreement? Or is all that going to the agreement?

Jay M. Gellert

All of that will go into the agreement. Ultimately, the amount we've incurred to date has not been included in the agreement.

Joshua R. Raskin - Barclays Capital, Research Division

So the $7.4 million so far, that is incremental cost. But -- so I guess -- I'm sorry, but is that different? Did you not expect that to occur in your guidance from last quarter?

Jay M. Gellert

The guidance we gave last quarter included no provision for the cost of the duals. At that point in time, we weren't fully sure when revenue was coming and when costs would be incurred. So none of that was in guidance. The amount that we've talked about in the second quarter had not yet been included in the risk-sharing agreement until we conclude a contract, then we would include all of the initial cost in the risk-sharing agreement.

Joshua R. Raskin - Barclays Capital, Research Division

So ultimately the $20 million, including the $7.4 million, will be reimbursed as part of that agreement?

Jay M. Gellert

Yes.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. So that's not -- and I'm sorry, but your guidance is not including that it gets reimbursed? Or I'm just trying to figure out what...

Jay M. Gellert

So the results to date don't include it being reimbursed. Ultimately we assume it will be reimbursed.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. When you say ultimately, does that mean in guidance?

Jay M. Gellert

The guidance assumes it will be reimbursed by the end of the year.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. So the true, true, incremental new costs in guidance are the $10 million?

Jay M. Gellert

No, it would be the $10 million and the $5 million because the reimbursement would only be 75%. So there's $10 million and $5 million in -- of additional costs in guidance. There's the $30 million, which is still in guidance, of which we've so far spent $10 million. So those are the changes we've made in terms of G&A in addition to the premium tax, which is -- has no net effect on income.

Joshua R. Raskin - Barclays Capital, Research Division

Got you. Okay. Now that I've thoroughly confused everyone else on the call, maybe something a little easier, the California...

Jay M. Gellert

But do you get it?

Joshua R. Raskin - Barclays Capital, Research Division

I do. $15 million, that's my number. The CalPERS, could you give us a sense, it's been a while since we've really tracked the CalPERS account. So what's the sort of opportunity? How are you guys thinking about potential membership next year? Is there a way to know how many are currently in HMO products or something like that, that would give us an indication?

Jay M. Gellert

I think it's too early to tell. I think we'll have a better sense when we get to the third quarter. We're still going through the process and I think that, as a new addition, we have to kind of do a little more work before we can quote it.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. And then maybe a different question. So the outsourcing agreement you guys have been talking about, any progress there?

Jay M. Gellert

Well, I think we continue to progress but I think the focus that we have right now is moving that forward but first tying down the duals and the -- and all of the work leading to the exchange.

Operator

Your next question comes from the line of Sarah James from Wedbush.

Sarah James - Wedbush Securities Inc., Research Division

In the prepared remarks, you said that you expect to be a significant participant in the California exchange. So I was just hoping you could give us some comments around what gives you confidence in your market share, maybe reflecting now that we have some information out on bids. And then if you could just touch on your pricing strategy for the exchange and why you priced certain products the way that you did?

Jay M. Gellert

Sure. First of all, I think it's hard to come to any kind of conclusion on membership because you -- we've never done this before. I think that we are very comfortable with where our products landed, in Southern California, where the vast majority of members are. As an example, I believe there are more members in San Diego county than all of the Bay Area. So I mean, it's -- the population that is going to be subsidized in the exchange resides largely in Southern California. The products that we've offered are products that have historically been successful with that population. The products that we've offered have been built off the existing experience we have with the small group products in those areas. We've made the appropriate adjustments based on the Milliman data that's been provided to us from Covered California. So in all, I think we feel very good, particularly when we look at the alignment between our product mix and the Silver Network, which would be the subsidized network. The key point I think we'd make is that when you look at the Southern California market, those Silver products are very inexpensive when combined with subsidies. And we think that there'll be a lot of activity around them and we think our -- the products we're putting in, the networks we're putting in represent the networks that have historically served those populations. And so combined kind of a good opportunity with a subsidized population. Again, the other thing everyone needs to bear in mind is I think there's a lot of speculation over the mix that will come in initially. But realistically, if you look at the way the 3Rs are structured, they're really structured to cushion against deviances in mix. So I think we feel that, with all the simulations we've done, that the history we've had with those narrow network products, their linkage to the places where there is significant concentration of new populations, the pricing, all lead us to feel quite comfortable with the offerings that we've made in the market and I think put us in a position where we think we're competitive. No one, I believe, can come to any final conclusion on how many people are going to be in. No one can come to any final conclusion on share. But that's the thinking and that's why we believe that the opportunity is very good. One final point. I think a lot of the discussion throughout the nation has been over timing, readiness and all that. I tend to think that the concern over those things are overstated throughout the country. But California has been working on this since day 1. So I think California has a significant head start in terms of the execution of just the mechanics of the exchange, which also give us comfort.

Sarah James - Wedbush Securities Inc., Research Division

Great. That's very helpful. And as you were running through those scenarios to price your product, did you consider or did you purchase some additional reinsurance that would lower the risk even more than what the 3Rs offer for protection?

Jay M. Gellert

Well, the risk corridors basically provide you 80% reinsurance. So the -- and then in addition to that, you have reinsurance between $50,000 and $200,000 for a claim and, in addition to that, you have risk adjusters in the population. When you combine all that with some of the risk arrangements with some of our providers, it's -- there really isn't much of a gap that would either be consistent with traditional reinsurance or be -- or offer much exposure.

Operator

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

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Yes. Just want to go back and make sure that I understood this correctly. With regard to what was not in your guidance, you're talking about $15 million in higher spending that you didn't previously contemplate in guidance. Is that correct?

Jay M. Gellert

Yes. There's $15 million in higher spending and then there's some reduction in the guidance in terms of Government Contracts and in terms of investment income. So that's the package of changes on the negative and they're balanced by better performance in Medicare and better anticipated fourth quarter experience in Medicaid.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Yes, okay. Okay, it makes sense. And can you just give us an update on the timing that you expect for the duals in LTSS and the size of enrollment that you anticipate at this point?

Jay M. Gellert

Well, first of all, in terms of timing. I think that the final issue that remains before us is coming to a conclusion on the rates. We're encouraged by the progress that has been made in Massachusetts. We have been told we're next in the queue to get these resolved and there's work going on. So I think that, that's the key timing barrier. The second thing in terms of timing of both CCI -- both elements of CCI, both LTSS and the duals, is -- relates probably more to when does that get finally resolved and then really a determination at the state. Do you want to -- where do you time it in the first 3 or 4 months of the year so as not to conflict with everything else going on and to guarantee that there's a smooth execution. One of the, I think, learnings that everyone has as a result of the SPD process is that once they got transitioned, it's worked really well. But the benefit of having a couple of months where you have information and you can plan the transition is immense, both in terms of the cost effectiveness as well as the member transition. So I think that's the kind of thinking going on. I think we're talking months one way or the other and I think it will be determined by those 2 factors. In terms of sizing, I think that there's a cap of $200,000 in the dual demo in Los Angeles. We -- I think we have no reason to believe that our share of that won't come into the program. I think we've had discussions with medical groups about wanting to transition some of their members into the demo early but we haven't yet resolved all that until we kind of get some of the final details worked out in terms of the CCI. We haven't had a final communication from the state in terms of how they're going to synchronize it vis-à-vis the duals. So all that's to come. But I think we're talking months in terms of transition and the broad numbers, I think, are consistent with the maxes included in the agreement between the state and the federal government.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

And just one other related to that. You mentioned Massachusetts and you probably know that a couple of the -- couple or maybe 3 of the plans have backed out of Massachusetts. How do you correlate their -- 3 have stayed in, too. But how do you correlate their decision with the type of structure that would work for you in California?

Jay M. Gellert

Well, I think that in the case of Massachusetts, they lacked the MA infrastructure, which we have in Los Angeles county. They, I think, lacked the kind of SPD experience we've all had with the groups. So I think that at the end of the day, that it was a different kind of program. It's a much smaller program and it's not as kind of, in our view, as kind of focused as the opportunity we have here. I think when you look at the numbers versus the baseline, I think we see that as -- the rates are fairly favorable in a fully managed environment like we have here. So I think that there's a difference in terms of cost structures and cost experience in Massachusetts. But if you apply it to our experience, I think there's some positive omens from the Massachusetts results.

Operator

Your next question comes from the line of Chris Rigg from Susquehanna.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Just wanted to come back to some of the questions on the guidance. I think I understand basically a $30 million-ish all-in headwind relative to prior guidance. But when I look at the commentary, at least in the press release, it seems like you're saying the Medicare business is operating consistent with your expectations. So I guess I just would love any color you could give on the relative performance between the Medicare business and the Medi-Cal segment or California Medicaid, generally.

Jay M. Gellert

Well, I think that the -- we said on the call in the first quarter that we were fairly -- being conservative about Medicare until we saw it play out. In actuality, I think our expectations are probably better than guidance and that's what's reflected in the kind of discontinuity between the 2 comments. So I'd say of the difference, the majority is Medicare and then there's some in Medicaid.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Okay. And then one bigger picture question, just with regard to the industry tax. I mean, how comfortable are you with sort of that being included in future Medicaid rates? And just more generally, your ability to sort of push that through on the commercial side at this point?

Jay M. Gellert

Yes. In terms of Medicaid, it's included in our risk-sharing agreement, including the gross up. So we feel like that's -- will be understood to be part of the entire process. So I think we have comfort, both because of the discussions we've had and the backup. In terms of the commercial market, I think it's the general pricing environment in the commercial market, not the insurer fee per se. And we have -- I think we feel comfortable in the exchanges. I think we feel comfortable with our narrow-network products. There are some instances where we're seeing unusually aggressive pricing but they're limited. And so I'd say that the fee is going to be a problem for small businesses and individuals who are going to have to carry it. But it really just factors into the overall pricing environment.

Operator

Your next question comes from the line of Justin Lake from JPMorgan.

Justin Lake - JP Morgan Chase & Co, Research Division

First question, Jay, you talked about the potential over time to outsource certain SG&A functions to improve efficiency, lower costs. Can you talk about the potential for timing here and also the magnitude of cost savings that you can see there?

Jay M. Gellert

Yes. We've indicated that in the proposal we've received already that all in -- that over a couple, 3-year period you can see $150 million to $200 million of savings on our present base. Nothing's changed our view in terms of that. I think that the issue of timing is kind of that -- you have a lot of planes lined up here on the runway and we're just trying to time them one by one. The key in our view is that, with our strong exchange position, with what we think is a really strong opportunity with the duals, with the positive circumstance in terms of Medicaid rates and Medicaid expansion, I think that we continue to aggressively pursue the outsourcing process. And my anticipation is that it'll be forthcoming kind of once we get through this next quarter or so to kind of get these other things tied down.

Justin Lake - JP Morgan Chase & Co, Research Division

Okay. And any numbers in terms of the charges, the cost that it would take to do that?

Jay M. Gellert

We haven't really gotten into that yet. I think they -- that we'll have to come back on it. There are various different structures we're looking at, and I think that the savings will be far in excess of the charges when you look at it in any kind of way, shape or form.

Justin Lake - JP Morgan Chase & Co, Research Division

Sure. And then lastly, you mentioned your bidding strategy for 2014 in Medicare Advantage being fairly consistent. I just wanted to see if you can delineate -- I mean, given the magnitude of cost cuts here -- or I should say reimbursement cuts for 2014, I'm curious, you've got a lot of capitated contracts. Can you tell us how you handled those capitated contracts in terms of how much of the costs are flowing through the physicians, just in terms of their piece -- their eating the rate decline versus cutting benefits to seniors?

Jay M. Gellert

Yes, it's a fair question. And I think it differs to a larger degree on their and our perception of the market. If the medical groups felt that there was membership risk in significant benefit cuts, then they've generally absorbed a greater portion of the cut. So what we've really done is gone market by market and group by group and said, "This is what we have to do. If we don't pass it through, this is what -- this is what it would look like, if we pass it through." And really sat down and made joint decisions in many markets on how to do it. I'd say that if there's a bias, that benefit reductions are easier to do and premium increases are easier to do when it's not moving from a 0 premium. So if I were to highlight kind of the general consensus when you talk to groups, they'd say that the first 2, they pushed us more aggressively on; the third, I think they recognized the disadvantages of doing that and were more open to accepting some of the cuts that were necessary in order to sustain that position.

Justin Lake - JP Morgan Chase & Co, Research Division

Okay. Can you tell us how many of your products are 0 premium in terms of your membership? Is it some percent? Can you give us a percentage?

Jay M. Gellert

I think we have to come back to you on that. I don't really have it and I'd be guessing. So let us call you back on that.

Operator

Your next question comes from the line of Ralph Giacobbe from Crédit Suisse.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Just going back to the cost side. In terms of the incremental investments this year that you're making in anticipation of next year, just wondering does any of that roll off in 2014? Or is that not the way we should think about it?

Jay M. Gellert

I think a significant portion of it rolls off. The exact amount, we'll have to see what goes on. But I clearly think, when you're looking at dual prep, that's -- and CCI prep, that's a onetime thing. And so I think that our goal is to maximize the necessary preparation this time in that regard. I would assume that some of the exchange costs would probably continue into the second and third year possibly. But we just have to see what plays out. But a good portion of those prep costs are onetime.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Okay, all right. That's helpful. And then around your commentary that you were seeing more interest in large group, particularly around the tailored network, any more details around that? Obviously, the enrollment numbers have been down in that segment. Just wondered how we should think about for '14? Is it a stabilization? Or actually can see some level of growth given the interest there?

Jay M. Gellert

Well, I think that we're seeing some accounts move fully there. And so I think that we're seeing some opportunities there. At the same time, that's probably the segment where we're seeing some aggressive pricing, too. So I think we're not -- I don't think I can come to a final conclusion. I do believe, though, that every product in the exchange is a narrow network. So we're all going to be moving there over the course of the next 12 to 18 months.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Okay, and then just my last one. The $25 million that you drew down on the revolver, what was that for? And maybe where would you target debt to cap at year end? And maybe, somewhat along those lines, parent cash dropped from that 31 to 7, maybe where should we expect that balance to be at year end, as well?

Jay M. Gellert

Yes. The cash at parent will be in the range that we guided to, which is a couple of hundred million dollars. The reason that we drew on the line was really a portfolio decision. We had certain investments at the subsidiaries that we decided we didn't want to break at this point in time. So it was just a balance. There's more cash at the subsidiaries, less cash at the parent, and that's really the difference.

Operator

Your next question comes from the line of Tom Carroll from Stifel, Nicolaus.

Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

So quick question on the reconciliation at days claims payable. Did the sale of your Part D business have any material impact on reserves and the time periods that you show there, on Slide 15? Or is something else causing -- the sequential decline first quarter to second quarter is really, I guess, the heart of my question on that. And then secondly, do you have an updated view on enrollment numbers in exchange products?

Jay M. Gellert

We -- yes. We -- let me deal with the enrollment issue first. I think we have not updated our view yet. We're still waiting to get a better sense of what's going on in the market. I think we're comfortable that there is no Part D data in terms of the days claims payable. The days claims payable, we indicated on our earlier call that it was higher in Q1 '13. We expected it to come down because of inventory reductions because we're getting less claims in, in Q2. But it's still 4 days higher on an adjusted basis than it was last year at this time. So I think we've indicated on our earlier call that, as fewer claims come in, we have our inventory drop. It has, fairly significantly. And since we haven't really reduced the number of people paying claims, we actually have a -- the reduction of, I think, $58 million in claims -- in dollar value, of claims inventory and that's what's reflected in this chart.

Operator

Next question comes from the line of Dave Windley from Jefferies.

David H. Windley - Jefferies LLC, Research Division

Just wanted to clarify a couple of things. So on -- going to the SG&A savings plans again. First of all, just want to understand, you've commented, Jay, that it's relative to your current base of business. So as you get to the point of being able to implement some of those things, does that hold your SG&A constant? Does it slow the growth rate? Or can SG&A dollars actually drop in absolute dollars?

Jay M. Gellert

Okay. With regard to that, I think our thinking is that as business grows, you'll probably get a proportional amount of savings on the growth business as you've gotten on the base business. So it would depend entirely kind of on how much we grow. When you add the dual CCI, the exchanges and Medicaid expansion, we'll most likely have an increase in G&A but it will be an increase that will be less the proportional savings that we've articulated in terms of the scale -- resolution issues.

David H. Windley - Jefferies LLC, Research Division

Okay. On the exchange, moving to that, you commented to an earlier question about your comfort with your position in the Silver tier. I wondered if you could provide some similar thoughts on Gold [ph] and Platinum, where your pricing is the lowest or among the lowest in those tiers, and perhaps explain your comfort level with that strategy, as well?

Jay M. Gellert

Yes, I think our comfort in Gold [ph] and Platinum rests with the fact that the HMO products are all managed by the medical groups. So they're not benefit managed as much as a PPO product. So I think that in that case -- our historical experience is that you don't have as much benefit flux with -- in a managed product because you're depending more on the medical groups to do the actual managing. We also believe that the risk adjusters are beneficial in terms of Gold [ph] and Platinum and detrimental, as we've all said, in terms of the Bronze business. So when we thought about it, that was the basis upon which we used both the historical experience in terms of benefits in the context of a managed product, as well as the relative effect on risk adjusters since the risk adjusters are run off of the average cost in the exchange, not the specific cost for the various tiers.

David H. Windley - Jefferies LLC, Research Division

Okay. And then last question, in the first quarter, you had commented on expecting buybacks -- stock buybacks to decline or recede going forward. I guess they were basically 0 in the second quarter. Is that the right expectation for the balance of the year that you wouldn't be active in buying back stock at all?

Jay M. Gellert

Yes, I don't think we'll be active until we get a good reading on the volume that we can anticipate from the exchanges, Medicaid expansion and the duals. We are probably more positive about the volume we're going to see. So we probably decided to be a little more conservative in the second half of this year in order to position ourself so that they -- so that we would have no difficulty meeting the requirements for regulated capital. So I think it really reflects more kind of a -- at least the sense that there's a possibly we'll have more volume than we originally anticipated.

Operator

Your next question comes from the line of Kevin Fischbeck from Bank of America.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

I don't know if you gave this number or not but what California risk-share payments did you receive in the quarter?

Jay M. Gellert

I believe we received $15 million.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And so that -- will you get 20...

Jay M. Gellert

We drew down $15 million, we didn't receive them.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay, drew down $15 million. And so I think last quarter you said that you expected $45 million for the year. Is that number higher now? Because I guess, it sounds like you expect to get another $15 million from the...

Jay M. Gellert

Yes, it could be higher. And I think the key point here is that, that some of the things we anticipated in terms of some of the revisions to the way we would operate have been delayed some. On the other hand, we have a much more positive rate environment beginning in October. So I think we feel comfortable that there's -- that this is basically a timing issue and that some of the things we're working on with the state have taken a little longer. On the other hand, the budget put us in a position where, beginning in '14, we'll be in a -- we think we're in a position where we'll be neutral or in a surplus vis-à-vis the agreement in terms of the basic Medi-Cal business.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. So for 2014, you still believe that it's going to be neutral?

Jay M. Gellert

Yes, we do. And the question you're asking depends on just the timing of a lot of stuff that's going on with the state. And quite honestly, the state's position, which is correct, which is the reason they put this kind of an agreement, particularly the 75% this year, was so that they could do it, given all the work they had, in due time, not be pressured. And so I think we're just -- we're working on a bunch of stuff. We've already got the rate increase, I think, through -- in terms of the initial material we've received from them. But it's -- but we're not -- I think the specific number for this year is -- still is influx.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And that rate update in Q4 is what you mentioned before? When you said that Medicaid will be better in Q4, it's because the rate update gives you visibility?

Jay M. Gellert

Yes. And it's the -- I think we've rectified a lot of the issues that agree -- that relate to the SPDs going forward.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then on the Government Contract business, you cut the guidance by $5 million. Can you talk a little bit about what caused that? I mean, is it -- is these -- are these adjustments to the TRICARE contract? Are they typical? Is it atypical? Is $5 million the right way to think about it? Or is the run rate for next year a bigger number? And if this is something that typically happens, is there always going to be risk going into Q2 or something? How do we think about that?

Jay M. Gellert

No, no. This is the way I think about it: The contract has a specific provision that relates the TRICARE costs to the overall medical expenditures in the country. The fact that medical expenditures in the country have come down some makes it so that, that factor works to our detriment this year. Ironically, next year, because of the implementation of Obamacare, it's going to have the opposite effect. And it will be, under the present terms of the contract, more favorable than it was detrimental this year.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. So you wouldn't -- this is kind of a 2013-specific issue. You think 2014, it's going to revert at least back to where it was?

Jay M. Gellert

Yes, I think that, that factor, if you assume that the overall expenditures in the country are going up, we'll adjust based on that experience. I don't think there's anyone who would doubt that at this point in time.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay, that makes sense. And then the interest rate -- I'm sorry, the interest income number that you mentioned, I guess, you talked about a similar issue as far as realized gains getting hit given the rising interest rates. Is there a rule of thumb when we think about that for you, like an x percent increase in interest rates equals y drag in investment income?

Jay M. Gellert

I think it's more timing as you reposition the portfolio given the interest rate experience. So I think it's less a static relationship than kind of more of a timing relationship and I'm not sure we've exactly assessed that to this point.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then just a couple last questions on the exchange. The commentary's been very helpful. I mean, I guess I agree with you a lot on what you talked about as far as Gold [ph] and Platinum plans. One thing I was really trying to understand was your commentary on the Silver plans. Because I guess I understand that, that's the only place you get the cost-share subsidies, which to me implies that people who are sick are going to be more likely to purchase that plan, whereas people who are healthy are going to be more likely to purchase the cheaper Bronze plan. Is that how you're thinking about it? And if it is how you're thinking about it, why aren't you worried about adverse selection on the Silver plan?

Jay M. Gellert

Two comments: First of all, our view is that all of the subsidized population will be driven to the Silver plan because that's the way it's constructed. Because if you -- in the example of, like, people at the lowest end of the subsidized population, they get something like a 15% bonus in terms of benefits by -- 15% to 18% bonus and benefit for basically free by picking the Silver plan. So we think it's much more income driven than health-status driven. Because someone who is in the subsidized population has only one benefit tier without regard to illness. So our view is that when you really look at it, particularly in the California exchange, particularly in Southern California, you come away with the fact that the Silver is kind of like a compelling deal for anybody who's in the subsidized population. In the other populations, I think that it -- that, if anything, I think that outside the exchange, you won't have that Silver bias at all because there'll be no subsidization for that population. So really, it's the benefit driver that drives the whole population.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Yes. I mean, I guess, I mean, I agree that it could be a really good deal. The Silver sounds like a great deal for very low income people. But if I think about uptaking that subsidy on Silver and then applying it to Bronze, I mean, there's potentially the ability to get a Bronze plan for free, isn't there? So wouldn't someone who is relatively healthy say, "I'd rather have the free plan because I'm not going to need it but, just in case, I'll buy it", rather than saying, "Yes, you know what? It's better for me to pay $500 and get really good coverage." You don't think that, that's going to be an...

Jay M. Gellert

Yes, I think $25 -- I think the reason we don't think that's true is that, particularly the healthy people and families, $25 a month is what they're going to spend out of pocket in the Bronze plan. So I mean, that's -- because of the deductible and the co-pay structure. So it -- the difference of that, like $25 is a difference between a 60% and an 88% benefit plan and it's particularly the front-loaded implications of the benefit plan. So most of those people are paying that kind of money out already in terms of out-of-pocket costs, which they'd have to continue to spend in the Bronze plan. I think it's a good argument if it's 60% versus 70% in the general population, it's people with money. But if you really look at the population that's going to be picked up in the exchange at the lower end, it's a lot of families.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then last question, I guess. Your commentary around the 3Rs mitigating adverse selection, was that meant from like a company perspective basis, saying that if you misprice your book it would kind of give you more cushion versus the peers? Or did you mean it really, from almost like an entire exchange perspective that if...

Jay M. Gellert

Yes, I think that -- yes, I think you're -- the point is that clearly, if you get no subsidized healthy people into the exchange, it has effects. But if you -- but if you're off by 5% or 10%, the 3Rs do a lot because the 80/20 protection is limitless. So the 80...

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

So did you price that way then, kind of assuming that there was this cushion there?

Jay M. Gellert

No, no. No, well, we priced assuming that if the mix was as projected, the product would work. But if because of all the publicity, the mix -- 25% fewer sign up or something of that sort, then that's what we viewed the 3Rs as providing adequate protection. It's particularly good if you're not an incumbent because you're basically not -- you're not ending up sacrificing business. So we took the position that the thing was going to work but we also did a number of simulations on the assumption that it wasn't going to work nearly as well as people thought. So we went through the process you just went through. We went through the process of saying people don't make rational choices. We went through the process of making -- of looking at if there was 50% less membership than expected, 50% more. And we looked at the various mixes of those kind of memberships. We looked at -- at your point, which is what if the healthy people go to Bronze? Actually, it's better for the Silver plan if all the healthy people go to Bronze because then the risk adjustment coming off the average rate as opposed to the specific rate in the Bronze product. The worst scenario we saw was a huge number of healthy people ending up settling in the Bronze. That was the scenario that had actually the most significant issues and it made actually the other product do better. Yes. Yes, I think that this is -- the point, I think, and we went to some of the sessions that were presented by the actuaries who are behind it. They said they want to make the sick better than the well and they want to make the Silver the dream product. And that when you really play with the way that the stuff is structured, it conforms with the way they articulated their goal.

Operator

Your next question comes from Ana Gupte from Dowling & Partners.

Ana Gupte - Dowling & Partners Securities, LLC

Just following up again on the exchange pricing. One of the things I observed when we looked at your pricing in Oregon and in California and we tried to get the most comparable off-exchange pricings from you for the same actuarial value product. First, is that in Oregon at least, we were able to find that. And it looks like you priced your Silver product lower on exchange than off exchange. So my question is are you in fact pricing some of the -- part of the 3Rs, the reinsurance into your pricing on exchange? And with that reinsurance, what types of target margins are you looking at that we -- booking, assuming all goes according to your base case scenario on participation and selection?

Jay M. Gellert

Yes. When we actually -- going to the first point, when we did the comparison, I think that you did, the effect you spoke of came from the increased subsidies from the government raising the benefit level. When we made that adjustment in terms of the determination, actually they were higher. We were pricing higher to reflect a different assessment of risk in Oregon. So we can go over that with you but that's what we found. So I think if you look at our products, we -- the federal government pays us for the difference in the Silver product, between the 70% actuarial equivalent and the actual benefit structure that you get as a subsidized member. And so we took that into consideration because it will be forthcoming as part of the overall process.

Ana Gupte - Dowling & Partners Securities, LLC

Okay. So it's about the subsidy but the $10 billion in year 1 that's being used to stop loss in that federal reinsurance program is an additional backstop? Should there be a better scenario?

Jay M. Gellert

Right, right, right. That's true, that's true. So -- but the benefit in the silver product -- you have to adjust the benefit level downward to reflect the fact that, for subsidized people, we will be getting a subsidy from the federal government to reflect the difference between the 70% benefit and whatever the benefit level is at that point.

Ana Gupte - Dowling & Partners Securities, LLC

Got it. Got it. Okay, so it's about the subsidy. Any thoughts on why a player like Kaiser, both in California and Oregon, would be so much higher than you, given they're vertically integrated? I'm assuming they have generally a cost advantage over most of the other guys.

Jay M. Gellert

Well, 2 points. There's actually an article in the LA Times, the front page of the LA Times that takes PERS Data [ph] and really challenges that -- the assumption you've just made in terms of the relative cost situation. But secondly, I think it's really a very, very telling sign of the difference between a full-network product and a narrow-network product. Kaiser didn't flex their network, everyone else did. And the net result of that change was really the significant difference in pricing. So I think it's a combination that as Kaiser has matured, to their credit, they've become a higher-quality, higher-service organization, but I'm not sure that their cost differential has been as great. And then secondarily and importantly, in none of the markets that I'm aware of did they do anything to focus on their lowest cost centers or their lowest cost hospitals or any of those things. And all of us, in preparing this, have over a long period of time built to develop that kind of thing. We would have a higher-cost product if we had, in effect, done it the way Kaiser did it.

Ana Gupte - Dowling & Partners Securities, LLC

Okay, that's helpful. So you're saying they did not try to change the network for the on exchange?

Jay M. Gellert

No, no. They didn't say like, "Here are our 5 best-performing centers and they're going to be in our product." They took the entire Kaiser system and offered it, as I understand it, in each of their areas. And again, to their credit, they really are focusing on differentiating themselves over time as much on quality and service as cost. And I think the combination of those 2 things led to the performance that they showed in the exchange.

Ana Gupte - Dowling & Partners Securities, LLC

Okay. One final question. For the reinsurance, I'm assuming, is trued up post facto and the same thing with the subsidies. I'm not sure what the timing is. So for the investment community, as we're trying to model out 2014 and beyond, do you see a delay in how you're getting the federal accruals for subsidies? And then should you see adverse selection with the reinsurance true-up happen much later, so you may actually see a lot of volatility in earnings next year?

Jay M. Gellert

Well, I think the accounting profession is presently working on how to treat all this. So it's premature for any of us to kind of articulate that. But I'll make a few points that I think are just principles and they're probably not -- they're not yet accounting law, so they all could be wrong. One is I think the 80/20 is fairly easy to calculate. So in theory, to the degree you get into the risk corridors, the effect of everything else is diminished by 4/5. Secondly, my sense is that they'll land -- but I'm -- this is just me speaking and I'm not an accountant, that there's pretty traditional reinsurance accounting. So that when we submit it, I mean, there's a methodology for doing reinsurance. The toughest nuts are the risk adjusters because they're relative. So everything else I kind of believe is -- there's a historical methodology for doing and it's -- and that I would assume the profession will come to a conclusion on that historical methodology, although I am not the person to opine on that. But the toughest nut is the risk adjusters because they're not only -- they're relative. And so until you have all the data, you really can't come to a conclusion on them. Our assessment is that when you package all that together, there'll be some volatility. But if it -- if there's -- the accounting principles generally follow what I said, they -- it won't be as hard to measure as you would think.

Operator

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

Christine Arnold - Cowen and Company, LLC, Research Division

A couple -- I'll make it like a bonus round kind of thing. You can answer quickly if you want. Capital. Will you need capital next year given all these new members? And if so, how are you thinking about that debt equity? Or is that a nonissue because of how much you have at the sublevel?

Jay M. Gellert

It's a nonissue because of the sublevel and because of the progression. That's one of the reasons why in the earlier question we're, basically for all intents and purposes, suspending repurchase just to be sure because we could end up with more than we thought and we just want to be ready for it. So the answer is no.

Christine Arnold - Cowen and Company, LLC, Research Division

No. Okay, no need for capital. And then if you're going to get big rate increases in both Medi-Cal and the SPDs, shouldn't you be reversing some of this receivable from the state? Why would you be taking out more than the $45 million? What am I missing there?

Jay M. Gellert

Oh, yes. The rate increases are coming in October and January, some in October, some in January. There are other things we're working on. There's a reasonable possibility we could see some reversals in 2014.

Christine Arnold - Cowen and Company, LLC, Research Division

Okay. Have you quantified those increases? Or is it premature?

Jay M. Gellert

I think we're still looking at them and we're still -- as we've said, there are some elements of the arrangements we're working on with the state that still need to be finalized. But I think that we feel comfortable that they're consistent with hitting the specified target and that there's a reasonable chance for some kind -- some reversal. That's why I think we're less agitated about all this than everyone else. Because in effect, I think that the situation we kind of had is that this was set up for exactly how it's played out. I mean, it's been set up so that we would not have craziness this year and we'd buy the time to fix it, particularly in light of the state's fiscal condition. And it's working exactly as planned. And so the ability to figure it out quarter-by-quarter is kind of not top of mind to us or top of mind to the state because they did this is so we wouldn't have to have this discussion.

Christine Arnold - Cowen and Company, LLC, Research Division

Okay. And then why outsource G&A? I would think that the growth you're going to experience with all these duals at a high PMPM, the LTSS at a high PMPM, all this Medicaid enrollment, a couple of hundred thousand individuals solves your scale issue. Why take the chance that you outsource this, and there's see an oopsie on execution? Doesn't all this membership leverage the SG&A and resolve the issue? Or am I missing something?

Jay M. Gellert

Well, I think that there's 2 issues that I'd articulate. First of all and foremost, and a lot of the work we're doing now is to de-oops it because an oops is a bad thing. So we are cognizant of the oops problem. The biggest issue I'd say we have is that we'll have significant aggregate scale but we're so diversified that it makes it so there really are opportunities for savings for people who are deeper. I personally believe that the banking system has kind of gone fully this way. I think our industry over the next 2 or 3 years has gone fully this way, anyway. And I think we just have to make sure that whatever we consider, we've adequately addressed the oops factor.

Christine Arnold - Cowen and Company, LLC, Research Division

And then final question from me. In May, you said you want a reasonable margin and up enrollment. Does reasonable margin mean that you'll maintain margin? Or that -- can you put some parameters around what you think a reasonable margin looks like in '14 relative to '13 for MA?

Jay M. Gellert

Well, I think it's -- I think that basically -- I don't think I said we would grow business. I'm trying to find out what I said, so I make sure I said right. I said...

Christine Arnold - Cowen and Company, LLC, Research Division

It maybe my issue.

Jay M. Gellert

Oh yes. No, I think what we said was we intend to focus on gaining enrollment where we can be economic and we would lose enrollment in places where -- to the earlier question that was raised, if a medical group and we couldn't kind of come to a conclusion, they thought we should eat more, we thought we needed to change the product, we were comfortable exiting those places or diminishing our involvement. So in aggregate we don't anticipate necessarily that we would grow enrollment. We anticipate that the growth we're going to have is on the MA side for -- of the duals. In terms of the -- our anticipation, I think that we can see some small attrition to margin potential next year. I think right now we're seeing good performance. We have to get ourselves comfortable with where we end up this year but I think that our goal is to kind of minimize any gross margin deterioration and to price that way and if it takes losing some members to do it.

Christine Arnold - Cowen and Company, LLC, Research Division

Okay. So MA excluding duals, enrollment down, gross margin deteriorates by less than 100 basis points. Am I summarizing what you're saying here?

Jay M. Gellert

I haven't -- we haven't gotten to the guidance point yet. I think we need to look at some stuff. But I think that what I did say was that we could tolerate some membership down and we would minimize the gross margin effect. And I'm not -- and I think that number -- I wouldn't even want to comment on because I don't think we've fully looked at it.

Operator

Your next question comes from the line of Brian Turner from Levin Capital.

Brian Turner

Just -- you just made a comment, Jay, where you, in response to Christine's question, you said "more than we thought" -- in terms of enrollment, more than we thought. Can you just help us understand what is it that you're thinking? Or an alternative way of asking is what should we expect in terms of membership at this point? What are the inputs that you're looking at to help us with that?

Jay M. Gellert

With regard to what?

Brian Turner

With just in regards to membership growth.

Jay M. Gellert

Yes, I think that there are kind of specific targets in the dual program that -- I don't think I've said more than she thought, I don't remember saying that. But I think what Christine...

Brian Turner

No, no, no. What you said was -- I guess she was referring to what happens with stock buybacks, why did you stop and you wanted to stop that, et cetera, just capital available. And you said, we stopped it just in case there's more than what we thought. And so obviously you're thinking something and I'm just kind of curious if you can share that thought?

Jay M. Gellert

Yes, sorry. I'm sorry. When we originally got into the issue of the exchange, we were talking 50,000 to 100,000 members. We were talking that -- we believe we will, if the exchange goes in any way like the way we think it is, we will get more membership than that. So I was really referring to the earlier discussion, which was probably at the first quarter, when we didn't really know how this all was going to play out. We didn't know how competitive California was going to be. We didn't know how competitive we'd be. And we had very low expectations for the exchange. So that's, I think, what I was referring to in terms of "more than we thought." We also had not kind of fully captured the fact that the state was going to go forward with the CCI on the Medicaid side. So those are probably the 2 things that would fit the "more than I thought" definition. But I haven't defined what I thought -- what I actually think now, other than to say those 2 things weren't factored in before and they now are -- they are now included in what we're thinking.

Brian Turner

And -- okay. And is there any way you can answer the question as to -- for '14, I mean, obviously, the opportunities are enormous. Can you just help me sort of think about how I go about, model -- what are...

Jay M. Gellert

You're asking me to -- I don't want to give guidance now because I don't have the data to give it. But let me give -- let me just conceptually speak. I mean, you can look at the -- there's a -- at the numbers in terms of MA -- in terms of the dual eligibles. I can't comment on pricing and I can't comment on mix because I don't know. You can make an assessment of market share versus the relative projections of the exchange. I think the exchange has come up with some range of projections in terms of what they expect. We want to see whether those materialize. We have some market share ideas, you can come to some market share conclusions. I think in terms of Medicaid expansion, Kaiser Family Foundation has come up with numbers. We're still talking to the state about exactly how those play, particularly in the context of the relationship with the counties because there's a separate county-type program that the state has put in that we would be involved in executing. And then finally, I think that the CCI, quite frankly, we are going back and forth just jointly in terms of the state, separate from the duals, to really just kind of understand exactly how this is going to play out. So I mean, you can get all the numbers and you can get kind of in some way the denominator by adding all of that up but I don't think we feel comfortable talking about the numerator at this point in time.

Brian Turner

I tried.

Jay M. Gellert

Yes, I know. I mean and you know, I mean, it's -- I think we've gone further than most other people have in terms of at least giving you a methodology to come to a conclusion. And I respect that you did try. And if you knew the answer, call me because I could use it.

Operator

Your next question comes from the line of Peter Costa from Wells Fargo Securities.

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

I'll try to be quick here. Just another point of clarity on your guidance regarding the Government Contracts business. You reduced that by $5 million. Is that the same $5 million that is the $5.6 million component of the $12.9 million charge? Because that's in the Government Contract line of the corporate.

Jay M. Gellert

No, no, no. The -- that reduction is in addition to...

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

So the Government Contracts business is actually $10 million worse than you originally thought it would be. Is that correct?

Jay M. Gellert

Well yes. And being totally honest, we -- it is even worse than that vis–à–vis our initial expectation. So it's -- on a -- based on where we gave original guidance, it's probably $15 million to $20 million less than what we've expected. We believe that most of -- that a portion of that, as we said in the first quarter call, is related to the fact that we had some business in the pipeline that has been halted by sequestration. The other part relates directly to this national trend factor discussion, which we had today.

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

Great. And then regarding the duals contracts, have you gone any further with your subcontractor relationships? Or is that still waiting for the rate?

Jay M. Gellert

Well, I think we're in discussions with people. But remarkably, most people want to see the numbers before they sign. That wasn't meant facetiously. So we're having healthy discussions. But just -- the difference between this and other states potentially where there are primarily fee-for-service arrangement is it's really much -- the provider relations depend a lot on what we get from the federal government and we're still awaiting that.

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

I was actually referencing your subcontractor relationships with other health plans but...

Jay M. Gellert

I think we're thinking about it all in the same context.

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

Got you. And then lastly, in terms of Covered California, in terms of your provider contacts with hospitals and doctors, have those been -- once people saw where your rates were compared to everybody else, are more providers trying to get into your networks? Are they trying to run away from your networks? Are anybody -- is anybody looking to change the structure of the contracts with you in terms of how the risk adjusters and risk scores play out?

Jay M. Gellert

No, I think that the main people we've talked to, we went through this all in advance of filing the rates. So nobody is surprised by the outcome of that. And we really methodically walked through our bidding strategy with our partners before we did it. So we have had inquiries about coming in and we just want to make sure that we give the business opportunities to the people who started with us and then as necessary expand. But right now I think we're feeling pretty comfortable because we did have that kind of dialogue in advance of the bidding.

Operator

Your last question will come from the line of Carl McDonald from Citigroup.

Carl R. McDonald - Citigroup Inc, Research Division

Two exchange follow-ups. So the risk adjustment and the reinsurance component seem relatively straightforward, you take money from one group of plans and you give it to another. The risk corridor, though, as far as I know HHS hasn't set any money aside for that. So it seems dependent on plans making more than 3% to contribute for there to be money going out to plans that make less. So just interested in what gives you comfort that, that risk corridor provision specifically actually will provide some protection next year.

Jay M. Gellert

Oh yes, fair question. The contractual provision is independent of funding. So the 3-year risk corridor is whatever -- I'm not conversant in the intricacies of the scoring but contractually it's an unconditional commitment.

Carl R. McDonald - Citigroup Inc, Research Division

Meaning that HHS basically has to come up with the money one way or the other?

Jay M. Gellert

Federal government, yes. Basically, it's in the bill. It's in the bill without -- as one of the elements that require funding. Subsidies go down. And then if they -- if -- or membership goes down and they need -- but that goes up -- I don't know exactly how that was all taken into consideration. But in terms of we -- in terms of the contractual relationship we have with them, they -- it isn't dependent on any kind of plus-minus funding.

Carl R. McDonald - Citigroup Inc, Research Division

And then just going to return to the back and forth between the whether subsidized members will choose a Bronze versus a Silver plan. Putting health status aside, if I make $16,000 today and I'm uninsured and I have some health issue, I show up at the hospital, I get it taken care of. They ultimately send me the bill and I just toss it because there's no chance I could actually ever pay it. Next year, when you're getting the subsidy, how do you think about just taking a Bronze plan, paying basically no premium? Yes, there's copays and deductibles, but you don't -- you're used to not paying them anyway, so you're just going to toss those bills just like you do today versus paying up for a Silver plan that will cover the copay?

Jay M. Gellert

Yes. Actually, I think that if the Bronze plan only didn't pay for hospitalization, I think there's kind of a somewhat of an argument here. The actuality is that it's less robust at the front end and that's where these people actually are paying out of their own pockets now. I mean, they can't walk into a drugstore and say, "I need this pharmaceutical." And the drug is -- and not pay for it. They access the primary care. Those are the areas where I think that the compelling difference exists between the 2 plans. So you have to basically come to the conclusion, if you run the numbers, that you're going to have no health needs except a catastrophic need. And the concern we had and we've articulated this before, that population is going to have such a low risk score, it's going to kill you in the Bronze product. So that's what I think our thinking is. If you are a person who's taking one drug of any significance, you will pick the Silver plan because of the coverage. If you are looking for a catastrophic plan -- I agree with your analysis. I don't think our view of that population is that way. But the scary thing about that is then you'll have a very, very low risk score. And the problem we saw is the risk scores are run off the average rate and if you have a low-cost product with a very low risk population, you've got -- we've come up with models where you could have negative premium. So our thinking is that -- somebody said this on one of -- somebody's call, which is you don't want the very, very healthy or the very, very sick. Anybody in between you'll do fine with. I think you're making a good argument for why the very, very healthy would pick the Bronze product, which is in our view, not a positive thing based on the way even the administration has articulated the plan but also based on our independent analysis of its structure.

Angie McCabe

Thank you, everyone, for joining us today. Have a good day.

Operator

This concludes today's conference call. You may now disconnect.

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