Aetna Management Discusses Q3 2013 Results - Earnings Call Transcript

Oct.29.13 | About: Aetna, Inc. (AET)

Aetna (NYSE:AET)

Q3 2013 Earnings Call

October 29, 2013 8:30 am ET

Executives

Thomas F. Cowhey - Vice President of Investor Relations

Mark T. Bertolini - Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Member of Investment & Finance Committee

Shawn M. Guertin - Chief Financial Officer, Chief Enterprise Risk Officer and Senior Vice President

Analysts

Justin Lake - JP Morgan Chase & Co, Research Division

Joshua R. Raskin - Barclays Capital, Research Division

Carl R. McDonald - Citigroup Inc, Research Division

Scott J. Fidel - Deutsche Bank AG, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Albert J. Rice - UBS Investment Bank, Research Division

Christine Arnold - Cowen and Company, LLC, Research Division

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

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

Sarah James - Wedbush Securities Inc., Research Division

David H. Windley - Jefferies LLC, Research Division

Ralph Giacobbe - Crédit Suisse AG, Research Division

Brian Wright - Monness, Crespi, Hardt & Co., Inc., Research Division

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

Operator

Good morning. My name is Lauren, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the Aetna's Third Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Tom Cowhey, Vice President of Investor Relations. Mr. Cowhey, please go ahead.

Thomas F. Cowhey

Good morning, and thank you for joining Aetna's Third Quarter 2013 Earnings Call and Webcast. This is Tom Cowhey, Vice President of Investor Relations for Aetna, and with me this morning are Aetna's Chairman, Chief Executive Officer and President, Mark Bertolini; and Chief Financial Officer, Shawn Guertin. Following the prepared portion of the remarks, we will answer your questions.

During this call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in this morning's press release and the reports we file with the SEC, including our 2012 Form 10-K, our first and second quarter 2013 Form 10-Qs and our third quarter 2013 Form 10-Q, when filed.

We have provided reconciliations of metrics related to the company's performance that are non-GAAP measures in our third quarter 2013 financial supplement and our 2013 guidance summary. These reconciliations are available on the Investor Information section of aetna.com.

Please note that the inclusion of Coventry's business in 2013 results impacts the quarter-over-quarter and year-to-date comparisons. We would also like to invite investors to mark their calendars for Aetna's 2013 Investor Conference, which will be held in New York City on December 12. Invitations for this limited attendance event will be sent shortly, and for those unable to attend in person, a webcast will be available.

Finally, as you know, our ability to respond to certain inquiries from investors and analysts in non-public forums is limited, so we invite you to ask all questions of a material nature on this call.

With that, I will turn the call over to Mark Bertolini. Mark?

Mark T. Bertolini

Good morning. Thank you, Tom, and thank you all for joining us today. This morning, Aetna reported third quarter results that included a full quarter of performance from the Coventry acquisition. Bolstered by the acquisition and continued strong performance in our Commercial and Medicaid businesses, Aetna grew medical membership by approximately 22% from the prior year quarter, reaching nearly 22.2 million medical members, grew quarterly operating revenue by 46% from the prior year, with operating revenues reaching approximately $13 billion, and grew quarterly adjusted operating earnings by approximately 11% from the prior year, with adjusted operating earnings of $604 million. Each of these quarterly metrics represents historic highs for our organization and a strong foundation to continue to expand our franchise to best meet the needs of both our customers and our shareholders.

Our diversified business model produced another solid quarter. Operating earnings per share were at $1.50. Pre-tax operating margins were 7.9%, consistent with our long-term targets, and we continued to generate substantial parent cash flow that we return to shareholders through our shareholder dividend and the repurchase of 5.2 million shares in the quarter.

As we look to the final quarter of 2013, we continue to project strong year-over-year operating performance, leading us to reaffirm our 2013 operating earnings guidance range of $5.80 to $5.90 per share. At the midpoint, our 2013 guidance represents 14% operating EPS growth in 2013 and 17% compound annual growth from 2010 through 2013, a 3-year growth rate that continues to exceed our diversified managed care peers.

At our Investor Conference last December, we outlined 6 critical tenants that support the Aetna growth story. Aetna's diversified portfolio businesses can grow predictably. Our Large Group Commercial business can grow profitably. Aetna's government franchise is a growth engine. Small Group and Individual are modest contributors to our consolidated earnings and represent an opportunity for future growth. Aetna's next-generation networks will enhance our core businesses, and Coventry is a strategically and financially attractive acquisition, which can accelerate growth across multiple lines of business.

I will now discuss some of the successes we had during the quarter that demonstrate the execution of our growth strategy. I will start with an update of our integration of the Coventry acquisition. The third quarter was our first full quarter of operations with Coventry, and while there is still much to be done, our results to date give us great confidence in our ability to achieve the high end of our 2013 operating EPS accretion targets of $0.20 to $0.25 per share. As we look to 2014, we are increasingly confident in our ability to accelerate the longer-term benefits of the transaction by achieving our synergy and accretion targets earlier than we previously projected.

Moving on to the Large Group Commercial business. We continue to believe that we are witnessing the start of a marketplace shift to private exchanges as plan sponsors move to defined contribution, converting self-funded membership into fully insured membership. We believe that this shift could provide greater consumer choice, empower consumers to take greater control of their health benefit decisions, enhance plan sponsors' ability to accurately forecast the cost of employee medical benefits and generate financial upside for Aetna shareholders, as fully insured membership typically generates 4 to 5x the profit contribution when compared to self-insured membership. We continue to position the company to capture our fair share of this opportunity, and we'll participate in many of multi-carrier private exchanges that are emerging today. We are also continuing to develop our own proprietary exchanges.

In contrast to multi-carrier exchanges, these Aetna marketplaces will be designed to cater to the specific needs of similar populations, including industry verticals. This stratification will allow us to: create unique network configurations and design accountable care partnerships to improve quality and lower costs for these customers; have a greater ability to deploy our population health management tools, including our advanced health care analytics to continually manage and improve health outcomes, creating a durable economic benefit for consumers and employers; and be able to offer a richer guided selling experience and incorporate advance tools, such as iTriage and Aetna's CarePass, to allow individuals to better interact with the system and make more informed choices. While still in its infancy, we are excited by the proposals for change in the large group commercial marketplace and believe Aetna's proprietary exchange models may offer both consumers and employers the most value over the years to come.

Next, a few words on our government businesses. As we have discussed on previous calls, Medicare Advantage rate pressures in 2014 will present a meaningful challenge for the program. We have worked diligently to bridge the funding gap created by these rate pressures in 2014 and continue to position Aetna to profitably grow as revenues approach parity with fee for service. Aetna was able to field competitive Medicare Advantage products across 959 counties or nearly 2/3 of the eligible population for the 2014 open enrollment period, which is currently underway. We continue to believe that the Medicare Advantage market will grow next year, and we continue to execute on our plans to solve the funding gap in 2014. However, our current projection is that Aetna's 2014 Medicare Advantage membership growth will be slower than last year, and the risk associated with closing the 2014 funding gap is greater than it has been in the past, which could pressure margins.

Another key component of Aetna's Medicare strategy includes the substantial investment we have made to improve our star ratings. The most recently released ratings are a testament to our execution of this strategy. Based on the new 2014 ratings data, which is the basis for revenue bonus payments in 2015, Aetna now has over 60% of our members in 4-star or greater plans, a meaningful improvement over last year and the highest percentage among national carriers.

In regard to public exchanges, their widely publicized challenges have been a topic of great public interest over the last couple of weeks. Aetna has maintained an active dialogue with members at all levels of the administration, and we hope this dialogue continues until the major problems facing this system are fixed. As before, we continue to work closely with government officials to help them improve the federal exchange enrollment process. Given the time necessary to implement the required fixes and the impact that these early struggles could have on enrollment, the success of the program remains to be seen.

Individual health insurance remains a small business for Aetna, approximately 3% of our projected 2013 operating revenues and an even smaller percentage of our operating earnings. As we evaluate our participation in the individual marketplace today, including market exits and prospects for membership attrition, we currently project that our overall exposure to the Individual business will not meaningfully increase in 2014.

Despite this context, it is worth highlighting how we positioned our products in the select number of public exchanges where we are participating. As we evaluated each rating area within a state, our decision to participate was based on geographies where we believe the demographics were favorable, often supported by high levels of subsidy eligibility. We had a competitive cost structure, often associated with a high-performance network or an accountable care organization. We believe there was a stable regulatory and competitive environment and ultimately, where we thought we could provide the most value to our customers while achieving acceptable returns and capital.

Specifically, Aetna's exchange products are most competitively priced in the catastrophic and bronze tiers and much less competitively priced in gold and silver. We did not file any platinum plans except where required by law. When combined with our other criteria, including where we could engage providers and achieve competitive cost structures, we believe our product positioning helps to mitigate risk.

We continue to believe that these emerging retail marketplaces can be successful over the long term and look forward to a timely resolution of the existing system issues, consistent with the administration's commitments to the public. We also continue to advance our strategy of provider collaboration as the vehicle for transforming the health care marketplace. At a high level, this entails entering into collaborative risk-sharing arrangements with providers, developing more effective and focused care management models, striving to improve the quality and cost effectiveness of the care being delivered, receiving best-in-market provider unit costs, launching new insurance products based on this cost structure and growing medical membership faster than the market at target margins.

As we noted in the past, ACOs and provider collaborations make up a meaningful piece of Aetna's exchange strategy. Our ACOs and high-performance networks enabled Aetna to attain highly competitive cost structures that we then built into competitively priced exchange products. A few examples: Through our innovation health partnership with Inova Health and our high-performance network with Bon Secours, in addition to other collaborative networked relationships, we developed competitive products for the Virginia marketplace. Our high-performance networks with Mercy Health and other systems are backing our products in St. Louis. And in North Carolina, our ACOs with leading health systems, such as Duke University Health System and Carolinas Health Care System, are at the center of our networks. Provider collaboration is an essential element of our strategy of transforming the health care marketplace, and our public exchange efforts are another example of how we are deploying this strategy to enhance the core business.

As we look past 2013, we continue to believe that our diversified portfolio and differentiated strategy position us to create long-term value for our shareholders. Given the level of uncertainty next year, we will not be providing specific 2014 guidance today. However, our preliminary view is that we expect the floor on our 2014 operating EPS to be consistent with our final 2013 operating EPS result. While upside to this preliminary view could be more difficult to achieve than in recent years, we are committed to growing both operating earnings and operating EPS next year. Shawn will discuss some of our specific opportunities and challenges in a few minutes, and we will provide detailed guidance regarding 2014 at our Investor Event on December 12.

In summary, we are pleased with our progress and execution. Our Commercial Insured business is performing well, benefiting from medical cost trends that remain low. Our 2014 star ratings are consistent with our stated goal: to have the majority of our membership in 4-star or better plans. Coventry is performing at the high end of our projections. Our initiatives to transform the network model and triple our value-based contracting spend by the end of 2017 are on track. Our capital generation is strong, enhancing our flexibility to execute upon our strategic vision and returning cash to shareholders. And we are confident in our 2013 operating EPS guidance range of $5.80 to $5.90 per share, projected results that would deliver a 3-year compound annual growth rate well in excess of our long-term guidance.

Finally, I would like to thank all of our employees for their dedication in meeting the needs of our customers. By focusing on sound fundamentals, creating new approaches to satisfying customers and generating and deploying capital responsibly, we believe that we can continue to create value for our customers and our shareholders.

I will now turn the call over to Shawn who will provide insight into our third quarter results, our updated 2013 outlook and our 2014 challenges and opportunities. Shawn?

Shawn M. Guertin

Thank you, Mark, and good morning, everyone. Earlier today, we reported third quarter 2013 operating earnings of $562 million and operating earnings per share of $1.50. These strong operating results continue to be supported by solid revenue growth and operating margins, as well as strong cash flow. I'll begin with some comments on overall performance.

From a top line perspective, we are growing. During the third quarter, operating revenue increased by nearly 46% from the third quarter of 2012, primarily from the addition of Coventry. We also grew medical membership by 22% from the prior year quarter. Sequentially, we added nearly 185,000 members with growth across each of our major product lines.

From an operating margin perspective, our businesses are performing quite well. Our third quarter total medical benefit ratio was 83.1%, a modest increase sequentially that is consistent with our full year projections and guidance. Our operating revenue growth, disciplined focus on costs and the Coventry synergies have driven 100 basis points of year-over-year improvement in our operating expense ratio. And our pre-tax operating margin was 7.9% for the quarter, consistent with our target operating margin range.

From a balance sheet perspective, we remain confident in the adequacy of our reserves. Our days claims payable were 45.5 days at the end of the quarter, stable sequentially. In addition, we experienced favorable prior period reserve development in the quarter across all of our core products, primarily attributable to 2013 performance and to our Commercial business.

Turning to cash flow and capital. Health Care and Group Insurance operating cash flows in the third quarter were over $1.1 billion, strong performance that represented over 2x quarterly operating earnings. We also continued to aggressively deploy capital to create shareholder value, repurchasing approximately 5.2 million shares in the quarter for approximately $330 million and delivering another $74 million to our quarterly shareholder dividend. Year-to-date, Aetna has returned nearly $1.2 billion of capital to our shareholders through these 2 programs.

In short, we are pleased with our third quarter results, which we believe demonstrate the successful execution of Aetna's growth strategy and the value of a diversified portfolio. The main driver of our strong operating performance this quarter and year-to-date is our Commercial Insured business. Commercial premium grew by over 24% from the prior year quarter, primarily from the addition of Coventry. As before and especially as we look forward to the changes we expect in 2014, we remain committed to fair and financially responsible pricing where we favor margin over membership and price to our projected medical cost trends. Our Commercial medical benefit ratio was 80.5% for the quarter, an excellent result as medical cost trends remain low, consistent with our previous projections. Based on our year-to-date experience, we continue to project that Aetna's standalone Commercial medical cost trend will be 6%, plus or minus 50 basis points in 2013. As a result, we continue to project that our full year 2013 Commercial medical benefit ratio will be between 80% and 81%.

Another important growth lever is our government franchise. Our Medicare business continued to demonstrate growth in the third quarter, growing by 35,000 members. In total, our Medicare revenue more than doubled over the third quarter of 2012, a result of the Coventry acquisition, as well as strong membership growth in Aetna's underlying Medicare business.

Our Medicare medical benefit ratio was 87.8% in the quarter, an improvement of 130 basis points sequentially. This result reflects the normal seasonal improvement related to the Medicare Supplement and PDP businesses, partially offset by the continued pressure from the 2 specific product offerings we highlighted on our second quarter earnings call, as well as sequestration. We continue to expect our full year Medicare medical benefit ratio to be at the high end of our mid to high 80s percent guidance range.

In our Medicaid business, medical membership increased by 19,000 members in the quarter, and premiums almost tripled on a year-over-year basis, reflecting the inclusion of Coventry. The underlying performance of the business was very good in the third quarter. Our Medicaid medical benefit ratio was 84.9%, an improvement from last year's third quarter. In particular, the hard work of our Medicaid team in Kentucky continues to drive progress, as that business improved again in the third quarter. Our year-to-date results continue to put us on track to achieve the low end of our high 80s Medicaid MBR guidance range for the full year.

Finally, I would like to make a few comments about our group business. Group operating earnings declined both year-over-year and sequentially, as we experienced higher claim incidents, primarily in our Group Life business. Our Group Life results appeared to be consistent with the statistical variance associated with this business. And this variance is not projected to continue in 2013. Our financial position, capital structure and liquidity all continued to be very strong.

At September 30, we had a debt to total capitalization ratio of 38%, achieving our year-end target a quarter early. Looking at cash and investments at the parent, we started the quarter with $200 million. Net subsidiary dividends at the parent were just over $1 billion. We retired approximately $550 million of outstanding commercial paper. We repurchased 5.2 million shares for approximately $330 million and paid a shareholder dividend of $74 million. After other uses, we ended the quarter with $200 million of cash at the parent, representing our core liquidity. Our basic share count was 367.5 million at September 30.

Based on our year-to-date performance, we continue to project 2013 operating earnings of $5.80 to $5.90 per share. This guidance, which would represent growth of 14% over 2012 at the midpoint, reflects strong performance in our Medicaid and Commercial Insured businesses, as well as continued execution of our expense management initiatives offset by the pressure in our Medicare and Group Insurance businesses. Aetna's adjusted operating EPS guidance range remains approximately $6.20 to $6.30 per share.

In terms of membership for the rest of this year, we currently project year-end membership of approximately 22.1 million medical members, as Aetna's exit from the individual marketplace in California and continued in-group Commercial ASC membership attrition are projected to reduce year-end medical membership as compared to our September 30 figures.

With respect to capital, we currently project net dividends from subsidiaries of approximately $2.5 billion, a $600 million increase from our previous guidance. This increase is driven by ongoing deployment of our strategic capital initiatives and cash management programs now also being utilized on the Coventry businesses. We have now increased our excess parent cash projection for 2013 to approximately $1.25 billion, and approximately $960 million of this excess parent cash has already been deployed toward share repurchases in 2013.

We now project our full year weighted average diluted share count will be approximately 360 million shares. The other components of our 2013 guidance remain unchanged and are disclosed in detail in the guidance summary document available on our website.

Moving on to 2014. As you know, we do not typically provide guidance on our third quarter call, and as Mark mentioned, we will not be providing specific 2014 guidance today. However, I wanted to provide you with some insight into the major items that impact our preliminary view of Aetna's 2014 earnings power.

As we complete our forecasting process for next year, we would note several opportunities to grow operating earnings and operating EPS, including the projected impacts of: fixed cost leverage as we grow revenue and actively manage costs, benefits from the Coventry acquisition that we are increasingly confident will exceed our 2014 operating EPS accretion target of $0.45, approximately $1 billion in share repurchases in 2014 and margin improvements in our businesses that are underperforming in 2013.

We are also incorporating a number of challenges into our preliminary views of 2014, including: the projected impact of prior year's reserve development, which was a meaningful contributor to operating EPS in 2013 and that we do not, as a matter of course, include in forward guidance; the projected impact of experience rated margin pressure in both our Large Group Commercial and Group Medicare Advantage businesses; lower projected benefits from early collection of health care reform fees and taxes, which increased operating EPS by approximately $0.15 to $0.20 in 2013; the risk that we are unable to collect 100% of the ACA-mandated fees and taxes, including the necessary tax gross up across all of our lines of business in 2014; and the risk as we work to offset the substantial rate cuts to the Medicare Advantage program in 2014.

In working through our preliminary view, we also considered additional factors that have been the source of earnings upside in recent years and the likelihood that they could recur, including: the likelihood that premium yields would exceed our initial projections as a result of having to collect ACA-mandated fees and taxes, and the likelihood that medical cost trends would increase by less than our assumed forward pricing trends after a sustained period of low utilization. The net result of these considerations is a preliminary view where we expect the floor on our 2014 operating EPS to be consistent with our 2013 operating EPS result, and where achieving upside to this preliminary view could be more difficult than in recent years.

I do want to reinforce the fact that we remain committed to growing both operating earnings and operating EPS next year and feel that our diversified portfolio and the benefits of the Coventry acquisition position us well to do so. However, at this early stage and in light of the magnitude of some of the uncertainties and challenges we face next year, we believe our preliminary view is prudent. We expect to provide additional details and specific guidance with our initial 2014 outlook at our Investor Conference in December.

I will now turn the call back over to Tom. Tom?

Thomas F. Cowhey

Thank you, Shawn. The Aetna management team is now ready for your questions. [Operator Instructions] Operator, the first question, please?

Question-and-Answer Session

Operator

Our first question comes from Justin Lake with JPMorgan.

Justin Lake - JP Morgan Chase & Co, Research Division

First question, on the 2014 outlook. I think the question is going to be in terms of this flat earnings growth. If I go back and just look at your initial guidance for 2013, right, kind of strip out the upside from PPD and the lower cost trend, you guided to $5.40 of EPS. And if I add on another $0.45 for the Coventry accretion that's expected this year, in 2014, you get to $5.85 with a little bit of -- and that's the midpoint of your guidance. So with a little share repurchase, one would think up. So is it fair to say that you expect your operating earnings, your core earnings to be down year-over-year? And can you walk us -- can you give us a little more color on what's going to be the main drivers of that decline?

Mark T. Bertolini

Okay. Justin, thanks. Let me make some overall comments, and then on the details of the headwinds and tailwinds, I'll turn it over to Shawn. First of all, it's still early in our operating planning cycle. We have another month of our operating plan review before we lock it down and know exactly where we are going. Secondly, there's a lot of change going on across the fundamentals of the industry and our own business. So 3 things that would cause me to think about what the challenges are next year: First, we have this Medicare Advantage funding gap we need to bridge. It's a big one. It's bigger than we've ever done in any year. I think that could be said for everybody across the industry. We've got line of sight into how to handle those, and so we feel like we have a plan to get there, but we don't have it locked down in our operating plan yet. Secondly, collection of health insurer fee, the HIF, is a big number. It's $600 million between Coventry and Aetna. Then you've got the tax gross up. Now in our Commercial business, we've got it into our pricing. 75% of our Commercial business is up in pricing. We're watching the concession pools to make sure we're getting all the money that we need to be getting in relation to the collection of the fee. So far so good, but we still have a lot of negotiation and contracts to lock down. In Medicaid, we put it into our pricing, but as you know, that's very fungible, and we're probably the most guarded about getting the money back in Medicaid relative to health insurance fee. And then third, in Medicare, we've got it, again, built into that funding gap, but again, that's a big funding gap. And then third, Coventry integration is going well. We're executing well against it. I always am reminded that the leading cause of failure is success, so we want to make sure that we continue to execute well against that. And the year-over-year difference based on our $0.45 in the second year is about $0.20 improvement or $0.20 to $0.25 improvement over where we guided for this year. So that's sort of how we think about it from a high level, still too early, a lot of change, and those are the 3 big issues that, I think, we need to be paying attention to, to make this work.

Shawn M. Guertin

I wouldn't add much to that. And I would reiterate, we've tried to stake out a floor here for you. And the reason the floor is there is, in my mind, just the risk and uncertainty around these 2 very big issues in Medicare Advantage, the Medicare Advantage funding gap, as well as the HIF. The 1 item I would point out, Justin, just in your thinking of rolling forward is also remember, in 2013, we had a $0.15 to $0.20 benefit from the early collection of the HIF, which is a nonrecurring type item in terms of 2014, where we're actually having to accrue the HIF.

Mark T. Bertolini

And I would just finally add, we are committed to growing operating EPS and earnings in 2014.

Justin Lake - JP Morgan Chase & Co, Research Division

Great. Can I just ask quickly the -- how did you price your book relative -- in Commercial relative to the 6% cost trend that you're seeing right now? Did you price for some cushion there?

Mark T. Bertolini

Well, we actually priced with a bias upward of utilization in 2014. We're not going to give guidance on our trend expectations for 2014 but definitely, an upward bias, particularly given everything going on with reform and the potential for higher utilization in 2014.

Operator

Our next question comes from Josh Raskin with Barclays.

Joshua R. Raskin - Barclays Capital, Research Division

Just back on 2014, could you just help us quantify -- my understanding of your favorable development that you've been reporting is that you guys switched from sort of net to gross, so I guess, the first question would be, how much of that PPRD is not replenished in 2013? What was the actual benefit, I guess, to earnings?

Shawn M. Guertin

Josh, you were breaking up a little bit, but I think you were asking me what was the benefit of prior year development in 2013 results. And as you mentioned, we have adopted a new disclosure policy of providing the gross development, but what I would do is I'd side step you back to Q1 of this year when we first -- when we made the first guidance increase of 3 this year. The performance increase was about $0.25, and that was almost entirely driven by the PYD. And I think if you sort of track our disclosure, since then, it's gotten a little bit better over the last couple of quarters. But that would get you fairly close to the number.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. So that's one. And then the experience rated margin pressure that you talked about, I think you said both in the Large Group Commercial and the MA Group business. How much of that was sort of given back, I guess, in terms of pricing for next year?

Shawn M. Guertin

Yes. Let me break that into 2 pieces. And again, these are directional estimates of where we are on this. But very similar to last year, at the end of the day, the Commercial MBR this year is 100 basis points better than we started the year. And I think going into last year, we said a set point for this business might be 81.5% to 82% as sort of an MBR when you price back to your pricing formula. So you could think about that as 100 basis points or 150 basis points potentially. On MA, the one thing I would say is it certainly will be less than last year. And last year was fairly large at 300 to 400 basis points. I would expect it would not be that high. It's still going to be meaningful. But not that high in '14.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. So just taking a step back, you guys are committed to growing operating earnings, which, based on share counts, repurchases, would almost, by definition, mean EPS growth. So I just want to make sure I understand the tone. When you say you're setting the floor, right, that's sort of a worst-case scenario, is that what -- are you intending that to be the low end of your guidance? Is that what you're saying? Or is that just, at this point, we can't see guidance coming in lower than this year?

Mark T. Bertolini

That is the floor, that is the bottom.

Joshua R. Raskin - Barclays Capital, Research Division

So that will be the low end of the range.

Mark T. Bertolini

At a minimum, at worst case, right.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. And then I'm sorry, last point on the Coventry synergies, you said you were accelerating the expected $0.45 earlier. Does that mean that it's going to be -- so I just want to make sure I understand. Is there upside to that $0.45 in your '14 expectations now?

Mark T. Bertolini

We are pushing to drive as much on the Coventry integration as we can get. We got more this year than we expected. Our goal is to get to the $0.90 full accretion as soon as we possibly can.

Operator

Our next question comes from Carl McDonald with Citi.

Carl R. McDonald - Citigroup Inc, Research Division

Just interested in how much visibility you have at this point on closing the Medicare Advantage gap. So if you're facing a 700- to 800-basis-point negative switch spread between pricing and the expected cost trend, how much do you know now because of benefit design changes versus how much you still need to get through provider contract and/or improved medical management or other things like that?

Shawn M. Guertin

Yes. It's hard to put specific numbers to that sort of across the country market by market. But as we stated, our solution to this was spread across the board. And I wouldn't say it was necessarily over-weighted to one component in the extreme at the expense of another. So obviously, the benefit changes we think we booked. Any revenue increase next year from STARs is booked. We've certainly made progress in the unit cost part of the solution and work sort of each and every day on the utilization management side of the solution. So we're deep into it. But as Mark mentioned, there's still a lot to be done, and there's a lot to be done and the clock is ticking. And in my mind, that is still one of the big open issues that I'd like to have a bit more information and data on before we make a more formal guidance commitment for 2014.

Operator

Our next question comes from Scott Fidel with Deutsche Bank.

Scott J. Fidel - Deutsche Bank AG, Research Division

First question, just interested if you can give us a preliminary look at membership trends for next year, at least in the Commercial Large Group and National Accounts business where all the business should have been finalized by this point.

Mark T. Bertolini

Scott, we see the membership in the Large Group ASC market as being stable next year. However, I think the membership number is going to be less important going forward than the revenue associated with it. So the with the emergence of private exchanges, which are not huge this year, but interestingly, large enough to get a view, you will see some self-funded membership disappear in exchange for fully insured membership, which carries 4 to 5x the dollar profit margin associated with the business versus self-funded. And so we're interested in that shift, and we're watching the 15 private exchanges within, which we participate in that shift from self-funding to fully insured. So I think the membership number is going to be less relevant in the future than the revenue number.

Scott J. Fidel - Deutsche Bank AG, Research Division

Okay. And then I just had a follow-up question, just on your thoughts on how the Commercial pricing environment looks at this point for '14. I'm really interested in 2 specific areas. One, just in Small Group, any variability that you're seeing in markets around early renewal strategies? And then two would just be around ASO fees and the large group market and just whether you've seen any increased pressure from the Blues for 2014, just given the significant membership gains that WellPoint's already guided for next year.

Shawn M. Guertin

Scott, on the Small Group pricing, I think you hit the issue that's going on in the market, and that is the early renewal strategies being utilized by probably virtually every one of our competitors market by market. That is going on out there. Again, I -- the market is always highly competitive, but it still is largely rational in my mind. The early renewal strategy has gone fairly well for us so far. We're happy with where we are in that process. And overall, the pricing environment feels fine. I wouldn't say that I would point out any particular trends in the ASC environment. I know some have commented that perhaps less is coming to market in general as a result of sort of the maybe wait-and-see approach on 2014, and we've certainly seen some of that in some of our segments.

Operator

Our next question comes from Kevin Fischbeck with Bank of America Merrill Lynch.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Just 2, hopefully, quick questions on the guidance for 2014. I guess, the first is, I wasn't quite sure what your commentary around the fees because you said that your guidance factors in some factors that have referred upside the -- or cost upside the last couple of years, which include cost trend in collection of the fees. What does it mean to have that factored into your guidance? Do you mean that you assume some of that will continue? Or do you mean that you assume it won't continue?

Shawn M. Guertin

So Kevin, let me take that one. I think we wanted to offer that commentary because it's been, obviously, part of our thinking as we are actively working through 2014. When you think about what often contributes to outperformance in this business, many times, it's margin being better than expected and in particular, underwriting margin being better than you expected. And when you think about the dynamics of that for 2014, and let's use Commercial as an example, it seems like the likelihood to push even more price than you're forecasting when you're already pushing maybe 400 basis points of price through for the health insurer fee and the reinsurance contribution, that just seems that, that's less likely to recur, not impossible but certainly less likely than may be in a "more normal year." If you go to the other side of the underwriting margin equation, as was alluded to before, we're assuming an uptick in utilization trend next year. And again, thinking about the prospects for medical cost trend coming in better than we're forecasting, after such a period of low stable utilization, again, it just seems that, that's less likely to recur. Again, it could happen. So it just when we think about sort of risks and opportunities, you are always thinking about those 2 factors and how you're positioned against them, and they just feel a little bit more constrained in 2014 than maybe in a normal year.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. So you didn't specifically break those out as headwinds, but you kind of feel like those things are headwinds essentially, right?

Shawn M. Guertin

I wouldn't really -- I mean, there's headwinds embedded. For example, the health insurer fee collection is embedded in my comments on yield, but no, they'd be rather -- they'd rather be things that could contribute to things being better than maybe you expected when you balanced all those headwinds and tailwinds. That's really all they are.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. So they're potential sources of upside but not explicitly forecasted either way in the model.

Mark T. Bertolini

I would call them limited variation.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Yes. Okay. All right, that's helpful. And then I think one of the things you mentioned was you expected an improvement in some of the underperforming businesses in 2013. I mean, MA obviously would have qualified but doesn't sound like that's going to be a tailwind next year. Are you just talking about the Group Insurance business? Or is there anything else in there that you highlighted underperforming this year, which looked poised to improve next year?

Shawn M. Guertin

No, they really are 3 specific items, and you hit them. The 2 specific, Medicare product offerings we talked about last quarter and the Group Life insurance.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. All right, that's helpful. And then maybe just one last question. I think coming into this quarter, you had kind of indicated that you thought Q3 and Q4 would be more equal to each other and not have the normal seasonality, which would imply something closer to like $1.44. You did $1.50. Did something change around it? I mean, it seems like there was upside to what you're kind of guiding Q3 to be like, but you didn't change the year-end number. Is there something to think about seasonality? Or how do you think about the guidance now?

Shawn M. Guertin

No. Actually, the quarter played out quite consistent with our forecast, and the words that we chose to be more evenly distributed were quite specific. They weren't intended to say it would be dead even between the quarters. So we knew we would have sort of a higher Q3 than Q4, but it would just be more evenly distributed than in the past. So again, the quarter played out quite consistent with our expectations.

Operator

Our next question comes from Matthew Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Yes. Could you just talk a little bit about the industry fee in Medicaid and if you can give us any specifics on where things stand in terms of state agreements to make you whole or at least in part, and how you think that's going to stand as we go into next year?

Shawn M. Guertin

Go ahead, Mark.

Mark T. Bertolini

I mean, Matt, the negotiations go like this. They agreed that the fee should be in the rates. And then we have a discussion about all the other factors that go into the rates, including prior experience. And to date, we feel reasonably good about the fact that we've been able to include them in our conversations, but we have more to do, and so there's still a lot of open switches. And as you've seen in the press, state budgets continue to be pressed. But in the cases, so far, we have been pleased with the discussions, but we are not done yet. So I would say of all the places where the trend could shift quickly, it would be in that area. Medicaid is probably the one we're most concerned about recovering the fee in.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

And as you have these discussions, is there -- how often do you encounter a distinction between the fee and the gross up for the tax deductibility impact?

Shawn M. Guertin

Again, Matt, I would say, it's very similar to what Mark says. It's acknowledged as an issue. And we're at various states of negotiation on it where, in many instances, it's been quite explicitly acknowledged that it is our cost, and we will get reimbursed for it. Others are more conceptual agreement with it, but it remains to be seen. But again, I think the good news is that it's acknowledged as a legitimate issue. Whether it ends up showing up in the final rates all in is still to be determined.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

And then just lastly on the fee on the Commercial side. I mean, it sounds like, if I heard you that you've got -- you have it fully baked in for 75% of your member months, maybe for 2014, if I heard that correctly? Is there any reason to doubt that it won't be 100% on the rest?

Mark T. Bertolini

As I mentioned, we have 75% of that priced into the market. We're still in the process of closing a lot of those discussions. So we're priced well in advance of the final date. And in the small group market particularly, it's always troublesome because you don't know you've lost a group until after the effective date a lot of times. So we are -- we take very -- pay very close attention to how all the pieces that we put into pricing, and then we have concession pools by market, and we watch those concession pools to make sure that we're not giving away the fee as part of those discussions. As I said, so far so good, but we are still early in the process.

Operator

Our next question comes from A.J. Rice with UBS.

Albert J. Rice - UBS Investment Bank, Research Division

I might just ask you about the -- your public exchange commentary. I know when we were talking in September, it seemed like you were still thinking through how you were going to account for this new category of members. Is there any update on that? And then also, with all the discussion about the delays in the rollout, potentially extending the open enrollment, delaying the penalty or even putting off the individual mandate for a year, how does that change your thinking? Or does it impact in any way your thinking about the exchange opportunity for next year?

Mark T. Bertolini

Well, as we looked, A.J., as we looked at the public exchange opportunity, we said we were going to be prudent. And that prudence was based on making sure that we were taking appropriate risks and that we had an opportunity to get a good return on capital while providing a valuable product to our customers. And so as I described earlier, we paid very close attention to the demographics in the marketplace, the level of subsidy and most importantly, our cost structure and ability to provide a valuable product. And the products that we were being competitive on are catastrophic and bronze. And so with that all in, Small Group and Individual are still a small part of our business, particularly Individual, 3% of our revenues, smaller than that of our profit, and so the amount of risk we're taking without any real increase in exposure there is minimal to our overall results. So we felt it was worth participating. We think it's still worth participating. We're still engaged. We are lending a helping hand in trying to get the enrollment process working properly. And we'll see what happens in 2014 as we get -- as we move toward 2015 and reconsider participation then. But I think right now this isn't a big exposure for us. It's an appropriate risk for us to take in testing a new marketplace, which we will think we believe will be around for an extended period of time and will be part of the marketplaces of the future.

Operator

Our next question comes from Christine Arnold with Cowen.

Christine Arnold - Cowen and Company, LLC, Research Division

A couple of follow-ups on exchanges. One, what would worry you in terms of the public exchanges, just following up to the last question. With an extension of open enrollments beyond a certain point in time with elimination of the Individual mandate, how are you thinking about the different levers that have been discussed impacting the exchange market over the long term of the public exchange market? And then with respect to the private exchanges, there's a thought that much more will begin on the ASO-oriented private exchanges. You seem to think that the shift to ASO to fully insured is likely to take off faster. Are there certain segments of the market where you think that's going to happen? Is it lower paid workers? Is it certain industry verticals? Could you give us some insight on that?

Mark T. Bertolini

Sure. On public exchanges, Christine, I think we worry about things like extended open enrollment and for how long that goes. We worry about the Individual mandate not getting stronger. Right now we don't believe it's all that strong and drives much behavior change, but we would like to see it get stronger as it is supposed to under the Affordable Care Act over time. So we think it's still important. We think the level of participation of the full population and the exchanges is important, so the enrollment process and the website is incredibly important to get right because as individuals try these websites, the younger, healthier people aren't going to give them more than one shot, and we think that has the potential to create some adverse selection in the pools in the first year. However, again, we've sized it for the exposure we have, and we don't view it as a significant issue for us in 2014. So we worry about all those things. We're engaged in deep dialogue on all of them and how we would like to see the marketplace evolve. But we still believe these are marketplaces that will be here to stay and that we need to participate in some way. On the private exchanges, we do believe that certain industry verticals and in -- certain industry verticals will cause self-funded to fully insure, but we think that will take some time. We are seeing some of that in 2014, and we will see more. We're seeing a lot of it in the group market as large group -- the Group Medicare market as large group employers move their retirees into private exchanges, and those are traditionally self-funded, supplemental policies for large employers that become fully insured in the marketplace. But we're also seeing some of that in smaller instances, the Aon Hewitt exchange has some of that going on as we speak. It's not big yet, but we think it's worth experimenting with. And we view it as a fair trade, giving up the self-funded market for that fully insured opportunity.

Operator

Our next question comes from Chris Rigg with Susquehanna International Group.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Just got a little confused when you were talking about the subsidiary dividends and the excess cash at the parent. I realize you're moving it up $600 million in terms of dividends, but the excess parent cash is only about $150 million delta relative to prior guidance. Is that all going to debt, repurchases? Just help me better understand that if you could.

Shawn M. Guertin

Yes, Chris. The biggest impact of that was paying down the Commercial paper of $550 million.

Operator

Our next question comes from Peter Costa with Wells Fargo.

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

A question here or 2 on the government business. First, you talked about Medicare growth being slower. Is that in Group or Individual or both? And then in terms of Medicaid, can you talk about what you're expecting for Medicaid regarding, in particular, the expansion in the woodwork effect for 2014? Where do you see that playing out in terms of membership? And which is going to be bigger, and then -- for you guys? And then which one -- how is it going to impact your loss ratios positively or negatively?

Shawn M. Guertin

On your first question on Medicare, Peter, we would expect growth but slower growth in both Individual, MA and Group MA in 2014. On the Medicaid, we have Medicaid growth in 2014. We have a number of contracts coming up, the dual contracts in Illinois and Ohio. The membership effect of that will be fairly small, but it, obviously, will have a more pronounced revenue effect. In addition, we have the floor to LTC, which will come online, same type of idea. And we also have Kentucky expansion coming online 7/1. That one may move the membership number a bit more meaningfully.

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

What about just regarding the ACA expansion, as well as the woodwork effect of people who today qualified for Medicaid but that perhaps could come out and sign up for Medicaid?

Mark T. Bertolini

Yes. We've heard rumor of the fact that a large portion of the younger population signing up are signing up for Medicaid. We've not yet seen it come downstream yet to us in the programs where we're involved. So that's an open switch for us. That's a possibility, and I'm encouraged by the opportunity there if we do have an expansion in Medicaid to take on some of that membership.

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

And what's your thought on the loss ratios of that business?

Shawn M. Guertin

Again, we -- with new membership, we never get too far in front of ourselves on that as we have to ramp up our quality management or our case management programs on that population. So I think I've said before, on a lot of the new populations, as a generalization, we'd be quite happy to be break even in the first year on the new membership. Again, to Mark's point, it remains to be seen. The profile of these members, one might think that they are a better risk profile than the typical new member, but that really does remain to be seen.

Operator

Our next question comes from Sarah James with Wedbush.

Sarah James - Wedbush Securities Inc., Research Division

You mentioned anticipating margin pressure on Large Group Commercial and Group Medicare from the experience rated. So I was wondering if you could remind us how much of your Commercial Medicare Group business have that experience rated aspect in the contract, and just talk about how the '14 adjustment may compare to '13 given that was a year where we also saw costs developing below initial expectations.

Shawn M. Guertin

Yes, we're roughly in the neighborhood, I think, of 50-50 now between Individual and Group in our MA profile. And the 50% of the group membership, as you would suspect, is highly dominated by larger groups that, by their nature, are experience rated, and so 50% wouldn't be a bad answer. We can get you a specific number on the Commercial business, but I would venture and estimate that we're probably talking 3/4 of our revenue plus or minus would be experience rated business.

Sarah James - Wedbush Securities Inc., Research Division

Which is how that compares to the impact this year, '13 versus '14 [indiscernible] ...

Shawn M. Guertin

Sorry, you're really breaking up. I can't hear your question.

Sarah James - Wedbush Securities Inc., Research Division

Sorry. If you could just clarify how the adjustment in '14 may compare to the one that you made in '13?

Shawn M. Guertin

Yes. So I think the '13 to '14 type adjustments would be similar on Commercial. And in terms of sort of the year-over-year effect of that, I would expect the overall impact to be diminished on the Group Medicare business from what it was in '13.

Sarah James - Wedbush Securities Inc., Research Division

And last question here is, looking at the bids for the public exchanges, it's strained as if you were very competitive on the PPO possibly than more so than the HMO. So can you speak to your PPO versus HMO strategy and maybe some of the work you've been doing to bring the cost bases down of the PPO exchange products?

Mark T. Bertolini

Yes. Our strategy was to take the best network contracts we could get in those markets, and they had to be markets where we had a good cost structure. And so those are largely are high-performance networks, narrow networks or ACO models that we had. Virginia is the example I noted in my talking points where with Inova and with Bon Secours, we have very good cost structure in the marketplace. It's an ACO. It's a PPO model. But it's a very strong form model that gives very good cost point in the marketplace.

Shawn M. Guertin

Yes. And I would just add that I sometimes think this distinction is a little bit too simplistic, and Mark just hit it, that many of these PPOs that we have out there are strong form PPOs with much more tightly managed networks and frankly, much more tightly managed unit costs on the out-of-network benefit as well. And one of the benefits of having a narrower network is not only the unit cost benefit but the ability to coordinate and manage care effectively in a smaller system.

Operator

Our next question comes from Dave Windley with Jefferies.

David H. Windley - Jefferies LLC, Research Division

Sticking with public exchange, Mark, I was hoping you could reconcile your comments around your participation, relatively cautious prudent approach with kind of the reality of Aetna being -- participating in the most states of any of the public peers. Could you help us to understand, say, peel the onion layer back a little bit to understand the prudence within the relatively extent of state participation that you had?

Mark T. Bertolini

Okay. First and foremost, it would have been prudent -- it would not have been prudent not to participate in the public exchanges. We think it's an important market segment that we needed to consider. Secondly, between Coventry and Aetna, we participate in 31 markets where we have significant membership in Individual. And here, we are limiting ourselves to 10 full states and 7 other states that are partial participation where we have a strong network opportunity, where we have a stable regulatory environment and where we can get a return on our capital. So -- and then we took all of that together and we said, okay, based on what we expect, which is no real significant increase if any at all in our participation in Individual, what would happen if we had the most -- the worst possible outcome with all of this membership from a financial standpoint. And we felt that, that was a risk worth taking, and we felt that it was not significant relative to our overall results. So that's why we chose to participate. We are a national carrier, so therefore, we have a lot more markets. But we are in a subset of the markets we participate in today.

David H. Windley - Jefferies LLC, Research Division

Okay. And from a guidance standpoint, can you talk about what the placeholder would be for your Individual exposure in that guidance where you're setting the floor of this year's number?

Mark T. Bertolini

The place -- the only place sort of we've given on our guidance around public exchanges that there will be no meaningful increase in our participation from a membership or revenue standpoint in the individual market as a result of our participation in public exchanges.

Operator

Our next question comes from Ralph Giacobbe with Crédit Suisse.

Ralph Giacobbe - Crédit Suisse AG, Research Division

I know it's a smaller piece of the business, but within your Small and Individual book, can you just give us a sense of what percentage of those lives are in plans that don't meet the requirements for next year? And then can you give us any color on what percentage of that Individual, Small Group has re-upped for 2014?

Shawn M. Guertin

Ralph, we can follow up on the specific numbers. From memory, on the Aetna book, we only had 150,000 members or so who were grandfathered, so the complement of that would be going into the market. Now the other thing I would point out on this is there is early renewal activity going on in the individual market, as well as the small group market, such that many of these members who do have to go in and pick a plan will not be doing so probably until the end of next year.

Operator

Our next question comes from Brian Wright with Monness Crespi and Hardt.

Brian Wright - Monness, Crespi, Hardt & Co., Inc., Research Division

Could you tell us the percent of your Small Group business group that you know has already early renewed?

Shawn M. Guertin

I don't have that exact figure with me. We can certainly follow up on that.

Brian Wright - Monness, Crespi, Hardt & Co., Inc., Research Division

And then if I can follow up, what was the -- and you may have said this already, but I apologize if I missed it -- the Coventry accretion in the third quarter?

Shawn M. Guertin

We didn't say that, but we continue to feel good though about Coventry producing at the high end of our 20% to 25% (sic) [$0.20 to $0.25] accretion range for this year of the business.

Mark T. Bertolini

$0.20 to $0.25.

Shawn M. Guertin

$0.20 to $0.25 for the full year. And we continue to feel good about the high end of that range.

Brian Wright - Monness, Crespi, Hardt & Co., Inc., Research Division

But specifically, in the third quarter, I'm assuming most of that $0.20 to $0.25 at the high end would be in the fourth quarter. Is that fair?

Shawn M. Guertin

There is a good chunk of it in the fourth quarter. You're correct.

Operator

And our final question comes from Tom Carroll with Stifel.

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

Just a couple of follow-ups items here. Shawn, I think you alluded to $0.25 as the amount of reserve development that may not repeat into next year. Is that a year-to-date estimate? Is that what you meant to say? And then secondly, did you suggest that share repo next year would be about $1 billion? Or did that also include some amount of dividend?

Shawn M. Guertin

Tom, on the first one, what I said is back in Q1 when we increased guidance, we had attributed $0.25 to performance, and that performance was almost entirely PYD driven. That number has grown in Q2 and Q3. If you look at our disclosures, you can see that, that has incremented up, so it is higher than that now. So on a year-to-date basis, to answer your question, it's higher than the $0.25. And we have also said, and it's a good working number, that we would have $1 billion approximately of share repurchase the next couple of years as we delevered. And as I mentioned, that's still a good working estimate for next year.

Thomas F. Cowhey

A transcript of the prepared portion of this call will be posted shortly on the Investor Information section of aetna.com, where you can also find a copy of our updated guidance summary containing details of our guidance metrics, including those that were unchanged and not discussed on this call. If you have any questions about the matters discussed this morning, please feel free to call me or one of my colleagues in the Investor Relations office. Thank you for joining us this morning.

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Aetna (AET): FQ2 EPS of $1.50 misses by $0.02. Revenue of $13B beats by $0.11B. (PR)