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Humana (NYSE:HUM)

Q2 2013 Earnings Call

July 31, 2013 9:00 am ET

Executives

Regina Nethery - Vice President of Investor Relations

Bruce D. Broussard - Chief Executive Officer, President and Director

James H. Bloem - Chief Financial Officer, Senior Vice President and Treasurer

James E. Murray - Chief Operating Officer and Executive Vice President

Steven E. McCulley - Principal Accounting Officer, Vice President and Controller

Analysts

Christine Arnold - Cowen and Company, LLC, Research Division

Albert J. Rice - UBS Investment Bank, Research Division

Sarah James - Wedbush Securities Inc., Research Division

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Justin Lake - JP Morgan Chase & Co, Research Division

Joshua R. Raskin - Barclays Capital, Research Division

David H. Windley - Jefferies LLC, Research Division

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

Ana Gupte - Dowling & Partners Securities, LLC

Scott J. Fidel - Deutsche Bank AG, Research Division

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Carl R. McDonald - Citigroup Inc, Research Division

Michael J. Baker - Raymond James & Associates, Inc., Research Division

Operator

Good morning. My name is Tamika, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2013 Earnings Conference Call. [Operator Instructions] Thank you. Ms. Regina Nethery, you may begin your conference.

Regina Nethery

Thank you, and good morning. In a moment, Humana's senior management team will discuss our second quarter 2013 results, as well as our earnings outlook for the remainder of the year. Participating in today's prepared remarks will be: Bruce Broussard, Humana's President and Chief Executive Officer; and Jim Bloem, Senior Vice President, Chief Financial Officer and Treasurer.

Following these prepared remarks, we will open up the lines for a question-and-answer session with industry analysts. Joining Bruce and Jim for the Q&A session will be: Jim Murray, Executive Vice President and Chief Operating Officer; Chris Todoroff, Senior Vice President and General Counsel; and Steve McCulley, Vice President, Controller and Principal Accounting Officer. We encourage the investing public and media to listen to both management's prepared remarks and the related Q&A with analysts.

This call is being recorded for replay purposes. That replay will be available on the Investor Relations page of Humana's website, humana.com, later today. This call is also being simulcast via the Internet, along with a virtual slide presentation. For those of you who have company firewall issues and cannot access the live presentation, an Adobe version of the slides has been posted on the Investor Relations section of Humana's website.

Before we begin our discussion, I need to advise call participants of our cautionary statement. Certain of the matters discussed in this conference call are forward-looking and involve a number of risks and uncertainties. Actual results could differ materially. Investors are advised to read the detailed risk factors discussed in this morning's earnings press release, as well as in our filings with the Securities and Exchange Commission.

Today's press release, our historical financial news releases and our filings with the SEC are all available on Humana's Investor Relations website. Finally, any references made to earnings per share or EPS in today's call refer to diluted earnings per common share.

With that, I'll turn the call over to Bruce Broussard.

Bruce D. Broussard

Good morning, everyone, and thank you for joining us. This morning, we reported second quarter 2013 earnings of $2.63 per share, above our previous expectations for EPS in the range of $2.40 to $2.50. These better-than-anticipated results were primarily driven by strong operating performance across our business units, partially offset by an accrual for expenses associated with Humana's upcoming exit from Puerto Rico Medicaid business.

Our second quarter's solid operating performance reflects the continued focus and executional discipline involved in the key initiatives, like our chronic care program, including increased care management professional staffing and clinical assessments. The favorable outcomes seen from these programs year-to-date reinforce our commitment to the related planned investments in the second half of 2013. We believe maintaining momentum on those and other key capable building initiatives, together with our focus on operating cost efficiencies, will effectively position Humana to face the reform-related challenges that accelerate in 2014.

This morning, we raised our full year 2013 earnings guidance to a range of $8.65 to $8.75 per share, from our previous EPS guidance range of $8.40 to $8.60, reflecting the outperformance achieved in the second quarter. Jim Bloem will speak more fully to our second quarter results in his remarks. For this morning's discussion, I'll focus my comments primarily on our Medicare positioning for 2014, our integrated delivery model, the build-out of our dual-eligible capabilities, the work we have underway around health care exchanges and our enterprise-wide focus on return on invested capital.

Let's begin our Medicare positioning. We submitted our 2014 Medicare Advantage and Part D plans' designs to CMS in early June. The CMS review process is underway, and it appears to be moving along well. The course of our bid preparation for 2014, we took our standard approach of having a multidisciplinary team evaluate markets individually, allowing all the areas of their expertise to weigh in on the many variables that impact each local market. We believe the favorable outcomes of our clinical programs facilitated our effective development of plan designs that reflect our strong pricing discipline and a focus on margin. We expect these plans will be competitive and continue to offer a solid value proposition for Medicare beneficiaries.

Another implication of the good work done through our clinical programs is that we anticipate only modest plan withdrawals in 2014. Approximately 78,000 or 4% of our individual Medicare Advantage members will not be offered their current Humana plan in 2014. Less than 6,000 of those members will not have another plan, Humana plan, for which to choose from for next year.

Consequently, we continue to anticipate growth in individual Medicare Advantage membership in 2014. That said, the funding pressures from CMS are still quite onerous. Facing these ongoing challenges makes continued investment and execution discipline, particularly for our integrated delivery model, all the more critical moving forward.

Turning next to our integrated delivery model, I'm pleased to note that we continue to make steady progress here. Providers are continuing to move across the engagement continuum. The number of risk and path-to-risk providers has risen approximately 30% when compared to this time last year, and path-to-risk providers are up 20% year-to-date. Improvement in the quality experience for our members is a key element of our integrated care delivery model. When the member is highly engaged, both the member and the member's physician are working jointly to proactively identify and address health issues.

As you'll see on this slide, bonus year 2014 HEDIS scores on highly engaged members averaged 4.14 versus 2.77, where the provider is not aligned to our integrated delivery model. This is particularly important for historic quality rate rankings. Ratings for bonus year 2015 are due out this fall.

While year-over-year improvement is difficult to predict with specificity, we anticipate our contracts will have achieved continued progress towards the coveted 5-star quality ratings.

As a reminder, approximately 40% of our Medicare membership is in plans with ranking of 4 stars or higher for the bonus year 2014. As we more fully develop all the capabilities of our integrated delivery model, we intend to leverage those capabilities across all our customer segments. We are also leveraging these capabilities to take advantage of the opportunity to expand our services to the dual-eligible population.

As I've said in the past, the dual-eligible opportunity is a strategic area of focus for Humana. Key capabilities in assisting states with growing health care costs include effective relationships with state and federal agencies in care management programs, particularly those related to chronic conditions, pre-65 Medicaid management, behavioral health management and long-term care management.

Over the past 18 months, we've executed on a strategy of leveraging our care management programs for our over-65 Medicaid members, while partnering with CareSource on the pre-65 population. The strategy has been successful in proposing solutions to states deserving a full-service benefit offering, while leveraging Humana's strong care management capabilities.

We recently announced our intent to purchase American Eldercare, broadening our portfolio of capabilities to include long-term care management, or aging-in-place, services for Medicaid recipients. This transaction also makes us well-rounded offering for the states.

Since long-term care accounts for a significant portion of Medicaid benefit spending across the U.S., we anticipate this will provide us much opportunity for growth over the next several years. Though the terms of the transaction were not made public, I'll share with you that the cash expended to be used in closing this deal should not impact our ongoing share repurchase or cash dividend activity.

The dual-eligible business is clearly complex. Our partnering and acquisition activity is helping us to streamline that complexity. While pricing negotiation with various states are still underway in many cases, we'll maintain the appropriate pricing discipline, particularly given that it is a low-single-digit margin business.

Our awards to date have been substantial. Revenues for dual-eligible and Medicaid awards, thus far, could potentially add revenues in the mid-single-digit billion dollar range over the next few years. Though the mix of lower-margin dual-eligible business with the higher-margin Medicare business will result in a decline for the retail segment margins over time, we anticipate the segment pretax results to expand nicely.

Turning now to health care exchanges. Our focus for the coming year includes 14 states with our existing HumanaOne footprint. We expect the exchange products to include primarily HMO offerings, with select market presence with each of the 14 states, ensuring we are offering a competitive and cost-effective value. The preparation process is tremendous, with short time lines for implementation. Nevertheless, our operational teams have risen to the challenge. Tactical plans for sales, enrollment and retention are well into the implementation phase.

We believe all this work will result in a measured entrance into the health care exchanges. These growth opportunities are expected to generally counterbalance from a risk perspective the 3 Rs: risk corridors, reinsurance and risk adjustment. We're also developing an expansive contingency plan since, as we've learned in the roll-out of the PDP in 2006, not everything goes as expected in these situations.

Our implementation of varying provisions of the Affordable Care Act that have already become effective is moving along well. We do not anticipate any material impact from the employer mandate provision that the administration has recently delayed. Finally, let me speak to our company's enterprise-wide focus on return on invested capital.

To clarify, this is an area that Jim Bloem and his team have had clearly in their focus for many years. In fact, with its strong organic growth, Humana is one of the limited number of companies in the S&P 500 who's ROIC has exceeded its weighted average cost of capital consistently for the past 10 years.

We believe this metric is particularly critical given the challenges the industry will face over the next few years. What's new here is that we are engaging more of our leaders across the company in this ROIC focus, as we believe it is a measure of shareholder value over the long term.

Earlier this year, we implemented the spread of ROIC over the weighted average cost of capital, as 1 of 2 measures in our performance share vesting, providing more widespread attention to the effective use of capital. ROIC compensation targets are not specific to the individual lines of business, but evaluated enterprise-wide to help ensure all our leaders use our capital judiciously. Our focus on ROIC has no impact on the Medicare margin targets we evaluate as part of our annual bidding process.

So in summary, we are pleased that 2013 results continue to come in ahead of expectation. Our strategy is on track, our business segments are delivering solid performance, and our execution focus is high. Despite near-term industry challenges, we believe Humana continues to have a bright growth future ahead.

With that, I'll turn the call over to Jim Bloem for the review of our financials.

James H. Bloem

Thanks, Bruce, and good morning, everyone. As usual, I'll first detail the quarter's results as well as our updated full year 2013 expectations before turning to our operating cash flows, financial resources and continuing capital deployment plans.

Starting with our second quarter results. We were pleased to report earnings per share of $2.63 per share, which exceeded the mid-point of our previous guidance by $0.18 per share, as indicated on the slide.

As Bruce referenced in his remarks, our 3 Puerto Rican Medicaid regional contracts, which cover 537,000 beneficiaries, were not renewed by the Puerto Rico Health Insurance Administration effective July 1, 2013. Accordingly, we recorded expenses of $31 million, or $0.12 per share, during the second quarter in connection with the wind down of these contracts and related administrative costs.

Contractual transition provisions require the continuation of Humana coverage for beneficiaries through September 30, 2013, as well as the processing of runout claims for the terminated contracts.

Though we sought to renew these contracts, we were unwilling to accept the inadequate returns that would have resulted from their retention. We continue to have a significant presence on the Island of Puerto Rico, serving 34,000 Medicare Advantage beneficiaries, as well as 72,000 Employer Group commercial members.

As also shown on this slide, our operating over-performance for the quarter was $71 million, or $0.28 per share, which in turn, allows us to increase our full year operating expectation by approximately the same amount. This over-performance mostly was due to a continuation of moderate medical cost trends in both our Employer Group and Medicare Advantage businesses.

With respect to our Employer Group commercial Medicare costs -- medical cost trends, we now see them in the range of 5% to 5.5% for the full year 2013. This represents only a modest uptick from 2012 levels. It's important to note that when we began 2013, we indicated that we were cautiously forecasting trends in the 6.5% range, plus or minus 50 basis points. We also have experienced favorable medical cost trends associated with the improved clinical program outcomes in our group Medicare business as well. Accordingly, we've raised our Employer Group pretax income guidance for the full year to a range of $250 million to $270 million, an increase of $60 million, or 30% at the mid-point, in order to reflect this more moderate cost trends in both our Employer Group commercial and group Medicare Advantage businesses.

We also have experienced favorable medical cost trends in the -- in our individual Medicare Advantage business. However, we continue to invest substantially in our chronic care capabilities with a focus on expanding the number of both care management professionals and clinical assessments to expedite the identification of members who would benefit from our clinical programs. We believe these investments generate deeper engagement with our members, which in turn, leads to improved health outcomes with a better consumer experience at a lower total care cost.

For this reason, and because of 3 other second half variables which we are continuing to monitor, we've chosen to leave our full year pretax income forecast for the Retail segment in the $1.3 billion to $1.4 billion range. The 3 other variables which we continue to monitor with respect to the Retail segment are as follows.

First, as always, we're awaiting the release of the Medicare Advantage competitor plan offerings, which annually occurs around the 1st of October. Evaluation of the 2014 competitive landscape will enable us to finalize our fourth quarter marketing plans in early October.

Second, we continue to monitor and ensure our readiness for the coming health care exchanges, since this remains a very dynamic situation.

And third, we continue to build out capabilities around our Medicaid and dual-eligible expansion strategy. Over the next 12 to 18 months, we will continue to expand our infrastructure in order to prepare for the ramp-up in this business, although again, the extent and timing also remain fluid as we work through the detailed rollout of these programs in the various states where we plan to participate.

Moving onto our health care services segment. These businesses are tracking in line with our previous forecast. And our pretax income guidance for the full year remains unchanged.

So in summary, we're pleased with this quarter's outperformance and have raised our full year earnings guidance to a range of $8.65 to $8.75 per share.

This final slide updates our 2013 operating cash flows, financial resources and continuing capital deployment plans. With respect to our operating cash flows, second quarter 2013 Generally Accepted Accounting Principles operating cash flows were $173 million, or $533 million lower than the $706 million we reported in the second quarter of 2012. There are 2 items which account for this significant difference, and both have already reversed in July. Here's the detail.

First, as is always the case, in addition to GAAP, we also evaluate our operating cash flows on a non-GAAP basis in order to assure that exactly 3 monthly CMS payments are reflected in each quarter.

As shown in this morning's press release, in the second quarter of 2012, this non-GAAP timing difference was $118 million of that $533 million year-over-year difference.

Second, in addition to the monthly CMS payments, we also received semiannual Medicare risk adjustor payments around midyear from CMS. Since June 30, 2013, fell on a Sunday, while June 30, 2012, was a Saturday, the 2013 midyear MRA payment was received on Monday, July 1, 2013, while the 2012 payment was received on Friday, June 29, 2012. The amount received in each year was in the range of $450 million to $500 million. Thus, together, the timing of receipt of both the monthly and semiannual CMS payments fully explain this year's lower second quarter operating cash flows versus the second quarter of 2012.

Most noteworthy in all of this is the fact that, based on today's increased earnings guidance range and the July reversal of these 2 timing differences, we've increased our full year 2013 operating cash flows guidance range by $100 million at the mid-point, to $2 billion to $2.2 billion range.

From the standpoint of our current financial resources, we're pleased report that as expected, the approximately $970 million of 2013 dividends from our operating subsidiaries, which we detailed in the first quarter call, were all approved and received by the end of the second quarter. This amount is largely reflected in the $883 million of parent cash and short-term investments at June 30.

The $883 million balance is after payment of first half 2013 quarterly cash dividends to shareholders of $83 million and share repurchases of approximately $210 million.

Finally, with respect to our second half 2013 capital deployment plans, we expect to continue our constant review of potential strategic investments and acquisitions, such as the American Eldercare transaction, which Bruce described, as well as the capital projects that we're always engaged in. At the same time, we expect to consistently return capital to our shareholders through our recently paid and increased quarterly cash dividend and our recently refreshed 1 billion share repurchase program, of which $871 million remains available with a June 30, 2015, expiration date.

With that, we'll open the lines for your questions. [Operator Instructions] Operator, please introduce the first caller.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Christine Arnold of Cowen.

Christine Arnold - Cowen and Company, LLC, Research Division

Thanks for the commentary on Medicare Advantage enrollment growth. How do we think about the margin? Because I mean, you bid assuming a certain loss ratio. And I know that the investments are something that could be fluid. How are you thinking about the loss ratio in 2014? And then is Eldercare accretive or dilutive? How do we think about that?

James E. Murray

This is Jim Murray. On the margin targets, as Bruce described in his remarks, I think we were pretty consistent with what we've always done over the last number of years relative to our Medicare Advantage individual targets. And because of the significant investments that we're making as an organization, that we go out of our way to talk to you about it. I think we feel pretty good about how those are all playing themselves out in terms of the assumptions that we used to develop those bids. So we're cautiously optimistic about that. And as respects with the American Eldercare, I don't think that we're saying anything about accretion there. I think it's an incredibly important acquisition for us, and we'll see how that plays out. And we'll talk about that more probably next year.

Christine Arnold - Cowen and Company, LLC, Research Division

Okay. And then you said consistent with the past few years, you've consistently said that you targeted a 5% margin, but you kind of moved away from that after the latest bids and thought more about long-term return. So when you say you bid consistently with respect to the past few years, are you saying you're targeting the 5% margin?

James E. Murray

Well, one of the things we have to deal with, as you'll recall, is the premium taxes. And so we had to modulate what we targeted in terms of our margins. So I would have said actually, that we probably had a higher target -- a higher pretax margin relative to what we've done in the past to make up for that premium tax issue. And so, again, I feel very good about the bids that we put out there. They're going to competitively allow us to, as we said in this morning's release, grow our Medicare Advantage individual business next year. And I feel very good about how it's playing out, as you see with some of the reporting that we did with respect to our trends this year.

Operator

Your next question comes from the line of A.J. Rice with UBS.

Albert J. Rice - UBS Investment Bank, Research Division

First of all, just maybe to drill down a little bit more on the MA plan withdrawals. So the 78,000 members affected, can you give us any more flavor for how concentrated that is geographically or other inputs that led to your decision there?

James E. Murray

This is Jim Murray again. I don't have the specifics on exactly where they were located. But I would tell you that it would be my opinion that those were probably in areas that weren't very highly concentrated and in parts of the United States that probably we don't have what we would call bold-moves focuses for us as an organization. And in a lot of those, as is indicated in Bruce's remarks, and I think the press release, we have other options for people to choose, which we think are fairly close to those that we had to eliminate. So that the ultimate impact was, I think, 5,700 people throughout the United States. And so we feel really good about that.

Bruce D. Broussard

I think it's really important because the team worked really hard to try to ensure that we offered a plan to as many of our members as possible. And I think this is -- it's better than what we thought it was going to be at the beginning of the year. But I will tell you, there's a lot of work that's been done to make that happen.

Albert J. Rice - UBS Investment Bank, Research Division

Okay. And then maybe my other question would relate to your comments about the exchanges. I think, Bruce, you mentioned that beyond the 3 Rs, you had some contingency plans that you're looking at in case things didn't go as planned, as they often don't in a situation like that. I wonder if you could expand on that. And also, I don't know if you could say anything about this. But as you gear up and think about these 14 states, can you -- is there any way to put any parameters around what would be a surprisingly good number of enrollees that you might pick up and sort of a bandwidth around what could happen, given your product offerings in those 14 states that you're anticipating?

Bruce D. Broussard

The latter question, we're not going to disclose that. I mean, we're -- it's a pretty fluid environment we're in right now. And I think just managing for what comes to us is the approach we're going to have. In regards to the contingency plan, we went into the bidding process and really were thoughtful around, actuarially, how we would approach this. And I think, as you look at the bids in each of the states and/or pricing, we're pretty much in the middle of the line here, not too aggressive and not at the lowest end there. In regards to the plan in my comments, it really comes down to systems around the, really, the implementation of the exchanges. And I just would say that we have a very good system back-up in a lot of different ways if something doesn't work. So it doesn't relate to the risk management side or relate, from a financial point of view, it really relates to the operational management.

Operator

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

Sarah James - Wedbush Securities Inc., Research Division

With respect to some of your Medicare exits, can you talk a little bit about the level of retention or switching into other Humana offerings that you could anticipate in the counties where your products are being discontinued? And then, as far as strategy goes, how much of your individual membership is in 0 premium plans for '13 and, thinking about plan design changes for '14, how could that change?

James E. Murray

This is Jim Murray again. The -- I think we referenced 70,0000-ish folks that are in plans that we had to think about discontinuing. And we've been very successful. One of the assets that we believe that we have as a company is the MarketPOINT representatives that have an opportunity to sit across the kitchen table from the seniors that they serve. And they talk to the seniors about options and strategies. And as a result of that relationship that they've created, we feel pretty good about our ability to have a conversation with those 78,000 folks and walk them to a Humana plan that makes some sense for them. So I can't tell you exactly how many of those will retain, but I would tell you that we probably feel pretty good about that. And your second question was?

Regina Nethery

0-premium plans for '13.

James E. Murray

I don't have it in my fingertips in terms of our 0-premium plans. But one of our philosophies is, and continues to be, to maintain as many 0-premium plans as is humanly possible. And obviously, as Bruce described when he went through his remarks, a lot of people get together every year as we're doing our bids and try to figure out, on a market-by-market basis, the dynamics, the investments that we're making, the trends, the -- all those things that we talked about so much in the past coming together. And we feel pretty good about our ability this past year to maintain that philosophy around the 0-premium plans. And you'll all see that in October.

Sarah James - Wedbush Securities Inc., Research Division

That's helpful. And second question, if you could just talk a little bit about your decision to enter the Mississippi exchange, particularly in the 36 counties with no competition, and how risk adjusters might work in that situation.

Bruce D. Broussard

Well, first thing is considering the population there, it was the right thing to do, I think, for us to go into that marketplace and to offer the insurance on the exchange side. In regards to how we approach it, it is a market that, since there will be only us in that marketplace, it does offer the ability to have a fairly reasonable rate there. So we look at that as an opportunity for us to protect ourselves. And then, in addition, we do have members today in that marketplace, both from a TRICARE point of view, we have a pretty significant membership base there, and then in addition, we have a Medicare membership base there. So we are going to an environment that we already are operating in. And so we feel comfortable with that. And then, at the end, we always said the 3 Rs will help us out in that particular aspect.

Operator

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

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Just wanted to come back to next year again. Did you -- where you're exiting or eliminating plans, is it mostly on the PPO side or is it a mix between HMO and PPO?

James E. Murray

This is Jim again. The -- by far and away, the most would be in the PPO space, which is, as we've talked in the past, our desire over the long haul is to get as many members and providers participating with us in HMO plans because they offer the best opportunity for us to provide economic value to the people that we serve. So that's what's happened in these markets that we haven't been as successful moving into the HMO kind of environment. So I would say most all of them were PPO.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Okay. And then just with regard to the employer segment results we're seeing this year. Obviously, doing better than you originally anticipated. Is the improvement entirely due to trend or is there some structural improvement that should help you longer-term here get that margin up from that 2%-ish level?

Steven E. McCulley

Hey, Chris. This is Steve. I'll speak to that a little bit. The improvement is largely trend improvement. And a lot of that we're seeing in the inpatient admissions trend being more favorable than we had planned. Also, our operating cost ratio, we're focused on making that better as well. And we're having a lot of success on that as well. So the combination of those 2 things are making the results better. And I do think the operating cost ratio is part of the infrastructure that will continue to run into the future.

Operator

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

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

A question about -- it sounds like you have sort of investing in the clinical management side of things and trying to shift the types of products that you're selling. To the extent that you're doing that within your product categories and I guess exiting PPOs and trying to get people into HMOs, can you give some thought about how you feel comfortable about seeing membership growth, since you're asking your consumer to kind of embrace a product which is, I guess, different than they've had in the past, and what experience you had doing this on other markets and how people responded to that?

James E. Murray

I think -- just to clarify something, when we talk about investing in our clinical programs, right now, it's a lot around our chronic care program. And our chronic care program has really shown some wonderful results, as evidenced by some of our over-performance this year. And as we look at that program, that is -- it has a lot of applicability to the PPO product. And that PPO product, adding that service is actually a very nice add to that. So it's not asking our members to do something that it is a choice. Meaning, that they're giving something up. It's actually a great add, and we have gotten just wonderful reviews back from our members on the effectiveness of that program, both from a lifestyle point of view and then, obviously, from a health point of view. So from our vantage point, it is actually a great service for our members, but it is primarily offered in the PPO product.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

[indiscernible] I was just going to say, that's interesting. But I guess, it would decide [ph] there's just the physician engagement side of things, which to me, at least, implies more network products.

James E. Murray

Yes. And the other thing that I would have added to Bruce's remarks is you -- and I think you see it in our stats. One of the things we do is not only try to get a model or a chassis built that features the HMO offerings, but we also try to sell people an HMO offering that may not have the full risk elements of it that we've talked about in the past. And so, that's a dual focus for us to try to get people to align around our HMO philosophies, and we've been pretty successful. I think we have about 50% of our folks in the Medicare Advantage individual business in HMO kinds of offerings, which is a good first step. And one of the reasons that I would opine on that that's happening is because people are used to those kinds of things, because they've grown up with their employer having HMOs and PPOs. And so, we don't see that that's a very difficult sell, and we've been fairly successful with that.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then, I just wanted to sort of understand a little bit more the return of invested capital thesis and how you guys apply that to your decisions to grow a certain business lines because you mentioned that the duals are going to be a lower than average margin business, which, to me, implies a lower return on invested capital, potentially, profile for that business. And then maybe the exchanges you target could also be a lower margin business as well. So how do you think about growing those businesses or even think about getting into Medicaid in a bigger way if those potentially have lower returns?

James H. Bloem

Yes. Kevin, it's Jim Bloem. Again, as Bruce referenced, we've been using this tool for a long time and have had great results with it in terms of consistency and the use of capital. But now, if you look at the last slide in Bruce's presentation, you can see those 17 businesses that are in the outer ring there, they're all different businesses and they all got different economic. They all require different capital. They all generate different returns. So the return on capital model, what that does is, it helps the company focus on, really, if you will, asset allocations and how we're going to make decisions and move capital around between those different opportunities that we have. And that's why we're bringing it up and we're making it -- giving it wider application throughout the management team. We're always, again, very dedicated to using it. But when you have a lot of different businesses whereas before, you go back 3, 4, 5 years ago, we were really in sort of a monolithic business that had capital requirements and returns.

Bruce D. Broussard

And related to that, you're asking specifically around the dual-eligible population. And the margins are less, but the actual dollar per case is much greater as a result of the conditions that, that population brings to needing services. And so, what we look at it is the absolute dollars that comes to the bottom line are much greater. And so, we look at that as a good returning business. The exchanges are a little different. They're smaller dollars, but there's less capital to be put up as a result of the less premium there. So the -- so we -- but those are great examples where the margin is impacted. But both for strategic reasons and for long-term returns, it's a good business to enter into.

James H. Bloem

And that's why we do it on a corporate wide basis, so that we can look at how does the -- how do all these things individually contribute to the whole.

Operator

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

Justin Lake - JP Morgan Chase & Co, Research Division

First question is on capital deployment. So with the rate pressure in Medicare Advantage making operating earnings growth more difficult the next couple of years, I want to get an update in terms of how you're thinking about the company's ability to deploy free cash flow and the under-levered balance sheet accretively to cushion EPS over the next couple of years.

Bruce D. Broussard

Go ahead, Jim.

James H. Bloem

So, Justin, I think, basically, we would look for the same kind of consistency that we've had in the past. We're always working every day to figure out how we can make the company more valuable by -- through acquisitions, by investments in capital programs, investments, et cetera. To the extent we have that and then we also foresee, as you -- as your question points out, that there are some headwinds in terms of the premium tax and the returns that we're going to be able to generate in the initial part. So if we're looking at that -- as we look for growth, then we look at the capital that we need after that. So if you look at -- we talked a lot today about what we're going to do in the Medicaid and dual-eligible programs. So that will require -- that will generate a lot of revenue. And that revenue will again require, from the states, a capital requirement that we'll have to satisfy. So our under-levered balance sheet, while it's more levered than it was last year, I want to make sure that everybody understands also that the rating agencies -- the credit rating agencies give us the flexibility to go up in the 25% to 30% range without jeopardizing our credit rating, which, again, S&P raised in the past quarters or in the past few days as well. So we want to make the company more valuable. We want to protect all of our optionality that we've developed with the balance sheet and continue to move forward. Now when we look at what we've done, I think that's -- while it's not guidance for the future, it's quite consistent in terms of how we split or balance between that growth and then the capital that we return through cash dividends and repurchase. And again, for the first half of this year, about $300 million. Those -- the total for those things for the last 2 years, $600 million for the full year. The 8 quarters that are left on the $871 million that's left in share repurchase, again, would indicate a rate per quarter, if you're going to do it that way, that would be very similar to what we've done for the last 2.5 years. So again, it's all a matter of continuing to look -- as we progress to look at all of our capabilities, what we still need. American Eldercare was a great acquisition for us. Again, thinking about that, thinking about those 17 companies that are on the left of Bruce's slides are very capital-efficient way to get those capabilities. So that's what I think we'll continue to do as we go forward.

Justin Lake - JP Morgan Chase & Co, Research Division

Okay. Great. And my second question is for Jim Murray. Jim, just following up on Christine's question, can you give us an idea of what the industry tax and the lack of deductibility means in terms of rate for Medicare Advantage? Am I right thinking it's like 70 or 80 basis points?

James E. Murray

I think that's a fair estimate. Yes, somewhere in that range.

Justin Lake - JP Morgan Chase & Co, Research Division

Okay. So in response to Christine's question, you said you took up the operating margin in the bid because you had to -- well, obviously, in order to offset the lower -- the impact of the 70 to 80 basis points. Is that right?

James E. Murray

We raised our pre-tax margin targets to account for the impact of the premium tax. That's correct.

Justin Lake - JP Morgan Chase & Co, Research Division

So if we start at 5% and we take out 70 or 80 basis points and we say that's the floor, and you actually took it up. Is it fair to say that, after the industry tax, the minimum after-tax margin that you would -- or, I should say, the minimum margin on a comparable basis would be like 4.3%, give or take, and it might be even better given the fact that you said you offset some of that industry tax? Is that a reasonable floor to think about?

James H. Bloem

I think the best way to think about it is -- you point out and again, this is exactly the way we think about it. We have 3 things we have to deal with in 2014 bids. We have to deal with the trend, we have to deal with the payment rate and we have to deal with the premium tax. We have 7 things we could do to handle those things. And in every market, as Bruce and Jim have described, we basically use those, although there's no algorithm or way to do it, we think about it individually. And I think, as Jim said quite rightly, that's one of the key competencies of the company is that, by market, we individually do these 7 different levers, everything from how much can we push back to the providers, where are star ratings, what are our trend benders, how much -- what can we look for in terms of competition. But in order to really see how this all turns out, we have our internal target, which is sort of our secret sauce. But until you see October and until you see what the other people have done in each of these places, and that's why the next call is the one that we're looking forward to, when we get all the information and so are you. That's really when we think this comes together in a way that really enables us to talk about this in the aggregate because we do it in the individual, but we don't have a real feel for the individual until we've actually seen the competitive offerings.

James E. Murray

And what I would add to what Jim just said is he talked about when we see everybody competitively in October, that will give us a sense for growth. But what, frankly, we're all looking at to make sure it continues and we're seeing that develop in the second quarter, as we've talked, is the beneficial effect of all of these investments that we're making as a company. To see how those are all coming together, we're making additional investments that we're feeling good about, but there's a lot of blocking and tackling that has to go on between now and then, and we want to feel better about those. So we can put all of this on a sheet of paper, and it can produce a number. But it's the day-to-day activity that creates the result that you're all looking for us to talk about, which we'll be more than happy to talk about next time we're together.

Operator

The next question comes from the line of Joshua Raskin with Barclays.

Joshua R. Raskin - Barclays Capital, Research Division

I guess, I want to concentrate on the 99% of your book that you're maintaining your products for your customers. And so, I guess, I'm curious. Is this indicative of a belief that there's a long-term sustainability of those product offerings, i.e. you won't expect additional market exits? Or will you evaluate things every year? And with the expected additional pressures into '15 and maybe even '16, there could be future exits? Or how do we think about that?

Bruce D. Broussard

Well, we always -- I mean, we always want to stay in the market. So that's -- I mean, our #1 goal here is providing its profitable and meets the targets we have. I think as we continue to see rate pressure coming down, then we'll have to evaluate markets we're in. This year, for all the reasons that Jim has said on many different aspects of the 7 different things we can do, we really focused on how do we create stability in the marketplace, maintain our margin and, at the same time, continue to be successful in the clinical area. And those 3 things have really allowed us, I think, to be -- to find a very good, for lack of a better description, compromise for our members for the rates that are being given to us and, in addition, for our financial performance. And all the hard work comes down to managing through that. And so, as we see coming years, we're just going to have to go through that process. We’re going to have to go through the processes. How effective can we be in our clinical programs like we have been historically. What markets we have concentration in and great relationships with providers and whether they're risk providers or path-to-risk relationships and what is our concentration of members in the marketplace from just size and scale. And those are the things that go into it. And the more the -- the bigger the rate cuts [ph] are, then the more we're going to lean towards markets that have better relationships with providers and more scale. And that's -- I don't know how best to answer the question more than that.

Joshua R. Raskin - Barclays Capital, Research Division

I guess, Bruce, maybe more specifically, if you were evaluating a specific product within a specific geography this year and you thought that you might be able to either -- I don't know what your metric is, it might be profitable and/or it might meet the weighted average cost of capital -- the return on invested capital would meet the weighted average cost of capital for that specific product. But that equation doesn't work for '15 based on what you're seeing. Did you stay in that market this year? Or...

Bruce D. Broussard

Yes. But we would stay in the market, providing that we saw growth coming in that marketplace. In other words -- so I think if the market doesn't look like it's going to grow and be successful and we can't get the infrastructure in there to support that marketplace, then we would probably exit sooner than later. But for the -- so if you're asking do we just sort of go down and say, "Where are we profitable?" And if we weren't profitable, then we exit it no matter what the future was? Or if it was profitable and the future was sort of not a growth market, would we exit? And I think all of those things went into it. I do believe that our team went into this with the ability to say, "Let's really look at markets that we have growth opportunities in both from a population growth, where we can be -- build successful clinical programs with physicians." And we can get those programs to the market as a result of our scale. So I would -- again, I come back to it. There's a lot of different variables going in there. But it does take a futuristic view of the success of that marketplace.

Joshua R. Raskin - Barclays Capital, Research Division

Got you. So your impression is that the markets that you're going to remain in next year, all but 78,000 of those members that have to shift products, the remainder are in markets that, it sounds like, you feel like have a future beyond just 2014?

Bruce D. Broussard

Yes, yes. Unless we have some shock that comes out, then we'll reevaluate and go a different way.

James E. Murray

That's what all these investments that we continually talk about are all about. It's to enable us to do that.

Joshua R. Raskin - Barclays Capital, Research Division

Got you. Perfect. And then, I know it's less than 24-hours old. But the CMS release and the PDP benchmarks for next year, I know you know your bids and now you know the benchmarks. Any surprises in there? Any takeaways that you guys thought about?

James E. Murray

On the PDP side, we were under the benchmark in all states or all regions, except for 1 small region, where I think there's some de minimis things that will protect us. So we feel pretty good about that. A little bit of a surprise with how much the benchmark changed favorably to the government, which I guess is what this is all about. It's a market-based situation. But as we step back and look at our strategies and philosophies, I think we feel really good about having a competitive product on the street that we feel really good about going forward. So somewhat of a surprise. But generally, we feel good about what we've bid and where we think it will have us on October 1 or whenever we get pictures of all our competition.

Operator

Your next question comes from the line of Dave Windley of Jefferies.

David H. Windley - Jefferies LLC, Research Division

So we calculate roughly that your investments that you've called out and talked about are maybe $0.80 to $0.90 this year. I'm wondering if you'd be willing to comment how even philosophically you will see those continuing? Would you be able to taper those as we move out of '13 into '14, or is the level likely to stay about the same?

Bruce D. Broussard

I would say -- and then, I'll ask Jim to comment further. Those investments will be inherently in our operating performance going forward because they are expense and not just capital investments. Now what we will see, as we did see this year from last year's investments, that we will see returns from that -- from those investments from the point of view of lower medical loss ratio. That being said, we do believe as we -- the program to the level that we need to over the next 18 months or so, then we'll probably see a slowdown of the incremental dollars that we are investing today. So I would suspect that we'll see a slowdown over the coming years. Jim, do you want to comment any further to that?

James H. Bloem

Well, yes. And again, I think the way we look at is, as long as there's good returns and as long as they're helping get the better outcomes and the better consumer experience and the lower cost, we'll continue to do it. And there's still -- as Jim and Bruce have said, there's still a lot of ground to gain there. Lots of people to put into these programs and to identify for them. So again, we feel that it's difficult right now to say that there's a substantial diminishing of the run rate of the expenses because there's a payoff.

David H. Windley - Jefferies LLC, Research Division

Okay. And then, coming back to MA, just to perhaps ask a question in a slightly different way. When you think about your growth for next year for Humana, the majority of your growth obviously comes during annual enrollment. I'm wondering if you do expect to grow doing annual enrollment for 2014, as well as picking up agents through the year. Maybe to parse out how you see the growth coming staged through the year, just as another way to ask the question, perhaps?

Bruce D. Broussard

Our anticipation when we talk about Medicare growth is that we would add membership beginning January 1 through the annual process. And then, in addition, we'll grow through the year with agents. I don't see us saying that we're going to have a dip or...

James H. Bloem

The pattern would remain as roughly the same.

James E. Murray

Yes. We have a target in mind for the full year that was a part of our bid process, and I think our MarketPOINT folks feel pretty good about it. And I wouldn't see that the pattern would change significantly from what we've experienced in the past.

Operator

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

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

You didn't provide third quarter guidance, as you normally provide the upcoming quarter. Is there any reason for that this time?

James H. Bloem

Peter, basically, what we did when we looked at it this year, there are a lot of things that are still in motion for 2014. And as you rightly point out, we normally do provide quarterly guidance. But in looking at what we still have to do, as I mentioned in my remarks, we still have -- we're still building the Medicaid and dual-eligible strategy. We're still looking at the exchanges. We have the marketing that -- which is -- that's the only 1 of those 3 that are -- that is the same as last year. So we thought -- just as a way of thinking about how we give guidance at this time of the year, normally, we give you the third and everybody solves for the fourth and it just sort of sets up an artificial barrier that when we get to the fourth, we sort of have to say, well, how did we ski through the allocation between those 2 quarters. So we thought it would be just better to say, at the midpoint, we think we'll earn $3.12 for the second half and just kind of leave it there. It's really not more complicated than that.

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

Okay. And then, last year, you spent an incremental $46 million -- I think the number was -- on clinical programs, and you were hoping to get sort of a $300 million return out of that this year. Can you give us an update on how that has performed? Have you gotten to those kind of levels of return? And then, in terms of the incremental spend this year, how much is it and then what do you expect to gain for next year?

James E. Murray

This is Jim Murray. We have teams of actuaries that are a part of our trend committee process, and they regularly evaluate our spend on all of the investments that you referred to. And I'm comfortable that we've done a pretty good job of getting to the ROIs that we had anticipated when we made the dollar spend. Now obviously, some of that was part of why we saw the trend improvements. But I will tell you that trend always continues. And so, you just can't add $300 million of profit because it's offset to some extent by trend. And so, we're very pleased with how all of these programs are playing out and are very, very disciplined and diligent about making sure that, when we spend the dollars for all these programs, that it pays itself off. We watch it very, very closely.

James H. Bloem

And I think the objective evidence of that is the fact that, at least, in these first 2 quarters, we've substantially exceeded the guidance that we've given. And the primary reason is, again, the moderation of trends.

Regina Nethery

This is Regina. [Operator Instructions]

Operator

Your next question comes from the line of Ana Gupte of Dowling & Partners.

Ana Gupte - Dowling & Partners Securities, LLC

The question was about your strategy with regard to exchanges. Aetna, CIGNA, United, have been pretty defensive, and it makes sense with regard to their individual and small group exposure. The Blues and WellPoint are more offensive. Your strategy on both participating and then, generally, the pricing range seems a little bit more offensive. I'm just trying to understand. Is this related to your strategy as being a consumer company, or is it more about you being a senior company and you're going after the pre-65s. And is there any downside risk on adverse selection, if you choose to preferentially go for the 55 to 65?

James E. Murray

The -- I'm not sure that I would call us offensive or defensive. I think we feel really good about the networks that we've built in all of the places that we're going to offer products for this category of individuals. I would tell you that the way we talk about it is getting our fair share of that opportunity. And when you think about what we're building -- and we keep talking about investments and I apologize for that. We're creating a chassis on which we can use to care for all of the folks that we ultimately have a relationship with. And we see the HumanaOne folks that are going to come into our rolls as a result of this exchange opportunity. And a perfect example, they're all HMO-based. Some of them may, as you've seen some press about, some of them may have conditions that we need to focus on. But lo and behold, we're building a very solid chronic care capability. So all we plan on doing is using what we've been building for the Medicare business and apply it to HumanaOne. So that's why we feel pretty good about the 14 states that we've talked about entering, and I think we have -- we believe we have the clinical infrastructure, on which to address any of the concerns that some of you may have.

Bruce D. Broussard

I just want to add. You mentioned that because we're a consumer company, which obviously MarketPOINT IS going to be used in the -- in our exchange product. And so, we're leveraging that. But as Jim said, I think one of the capabilities that the organization really looks at in deploying into the exchanges is the clinical programs. And to us, that's where we are -- probably our sweet spot is. It's been demonstrated over the years in the Medicare program. And as we look going into this, that's probably where we'll see us being able to have the most impact on people's health.

Ana Gupte - Dowling & Partners Securities, LLC

So just, I'll just quickly recap, and I'll stop there. So it's not about pre-65s, and you're getting Medicare-like rates on an HMO chassis. Is that a fair assessment?

James E. Murray

Yes. I think what you're implying, and we do talk about this, is this is an opportunity for us to provide coverage to people for their lifetime. And so, this is a nice opportunity to create a relationship with somebody who is under age 65 and have them age into our Medicare programs. So if that's what you're implying, I would say, yes, that's a part of what we're thinking.

Bruce D. Broussard

And also have relationships with people that are already in Medicare.

Operator

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

Scott J. Fidel - Deutsche Bank AG, Research Division

I just wanted to stick on the commercial individual and small group and just 2 questions there. One, are you seeing any evidence yet of small employers starting to drop coverage at all, ahead of 2014 at an increasing pace. It's just something that WellPoint had suggested on their call, but haven't heard many of the other plans confirming that at this point. Then, just second, just on the individual membership guidance, it looked like you bumped that up. Is that just more a function that the products' been growing better-than-expected so far this year, or are you now not expecting to see as much attrition in the back half of the year leading up to exchange open enrollment in October?

James E. Murray

On your small group question first. We're seeing some pretty nice growth in our small group business. In fact, there's a movement by a lot of companies to renew early, and we're seeing the beneficial effect of that. So that's actually been one of the areas of nice growth for us. So we haven't seen that occurring, perhaps, as one of our competitors that you referenced that. On the individual, frankly, I've been a little bit surprised. We actually thought that, on the individual business, that people would be holding in place until the exchanges came into view. And actually, what we've been seeing is that there's a pretty fulsome marketplace for that, and you're seeing the beneficial effect. We had actually thought, as our guidance previously suggested, we were going to go down and we're actually seeing some nice growth. And so, we tried to figure out what that might be all about. And I guess, the best thing that I've heard is that people are beginning to understand that they need to buy coverage. And so, they're making that choice now. But that's only somebody's guess as to what's occurring. So I don't have as much insight on that as I'd love to have for you.

Operator

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

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Just a numbers question. One, if you still see the benchmark rate being down. I think you're pretty specific down 2.8% before the impact of the premium tax. And so, 280 basis points down. Secondly, should we think about the premium tax being about 1.5% of Medicare Advantage premium?

James H. Bloem

Oh, yes. The answer to both questions is yes.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Okay, okay. Got it. And just one other, if I could slip this in. Can you talk about directionally where you think you'd be on after-tax margin going into 2014? I mean, I appreciate the commentary on pre-tax margin. But of course, as you guys know very well, it's less meaningful at this point going forward, given the impact of the industry fee.

James H. Bloem

Well, Matt, all I can tell you is you know that our tax rate is very consistent in terms of our statutory rate and our effective rate are pretty much the same. So it's really -- it's a derivative of the same question. So we really can't answer it.

Operator

Your next question comes from the line of Carl McDonald of Citigroup.

Carl R. McDonald - Citigroup Inc, Research Division

I was hoping if you could just remind us of your historical approach to new Medicaid contracts. I think the Medicaid plans have historically, generally assumed breakeven in the first 2 quarters and then normally come back 2 quarters later and say they're actually going to lose money. I'm asking in the context of American Eldercare and particularly thinking about, I think some of your comments in the past were maybe less than happy with some of the rates that the winning bidders were able to get on that long-term care RFP?

Bruce D. Broussard

Well, let me try to say this on 2 different ways. First, as we've articulated, we -- pre-65, we really are relying on CareSource to be part of that bid process. So they really are the entity that is bidding and, for the most part, taking the risk on that. And so, when you talk about the Medicaid contracts, historically, Kentucky being probably the poster child of that over the number of years. That would really come from the CareSource side. In regards to the long-term care aspect, the -- there's a few things there. First, there is a collar [ph] in Florida for the first year or 2 to get some experience behind us. And so, as we look at going into it over the next 12 to 24 months, there will be a lot of learnings from that. Although that what we have seen is that in the states that have done this, Tennessee being one, Arizona being another and there's a few regions in Florida that have done this, there has been a very strong success in being able to manage the expenses on the Medicaid side, specifically on the nursing home side. And it has both been good for the state and has been good for the participating organization that has done that. Because it's similar to other parts of Medicare Advantage, as a great example. Your benchmark is your existing cost structure, which that existing cost structure really doesn't have any efficiency. And so, what we see is, is when you're compared to that, you have a lot of opportunity.

Operator

And your final question comes from the line of Michael Baker of Raymond James.

Michael J. Baker - Raymond James & Associates, Inc., Research Division

Just a follow-up on the American Eldercare. Are there any enhanced capabilities that you're getting through the acquisition, or is it pretty much just a way to get a ticket to the long-term care dance?

Bruce D. Broussard

No, it really added -- it added some capabilities too, to what we have. Some of the activities that they are doing, we actually were outsourcing at the time. And so, when we won the 3 contracts, we were outsourcing some of those capabilities. So it was very much of a strategic acquisition for us. As it was, it brought a great number of Medicaid lives to us in the elderly population, which Florida is a big market for us. So it both was a good business, but also a good strategic acquisition for us. And we think it is -- it really is a wonderful deal for us in multiple different ways and, frankly, for the state as a whole. I think our -- taking our capabilities and bringing that together with our market share in the market in Florida and, in addition, our chronic capabilities, I think everyone wins on this.

Well, I think that's it. We really appreciate, as always, everyone's support. And this could not have been a successful quarter without our 50,000-or-so associates working hard every day. So I thank them for all the work that they've done over the last quarter in making this a successful quarter. So thank you. And again, we appreciate your support.

Operator

Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect.

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