WellPoint Inc. (WLP) Q4 2009 Earnings Call January 27, 2010 8:30 AM ET
Angela Braly - President & Chief Executive Officer
Wayne DeVeydt - Executive Vice President & Chief Financial Officer
Ken Goulet - Executive Vice President & President of Commercial Business
Brian Sassi - Executive Vice President & President of Consumer Business
Michael Kleinman - Vice President of Investor Relations
John Rex - JP Morgan
Justin Lake - UBS
Charles Boorady - Citi
Doug Simpson - Morgan Stanley
Josh Raskin - Barclays
Matthew Borsch - Goldman Sachs
Christine Arnold - Cowen & Co.
Carl McDonald - Oppenheimer
Scott Fidel - Deutsche Bank
Kevin Fischbeck - Bank of America
Ana Gupte - Sanford Bernstein
Matt Perry - Wells Fargo
Brian Wright - Collins Stewart
Tom Carroll - Stifel Nicolaus
Ladies and gentlemen, thank you for standing by and welcome to the WellPoint conference call. At this time all lines are in a listen-only mode. Later there will be a question-and-answer session; instructions will be given at that time. (Operator Instructions)
I would now like to turn the conference over to the company’s management.
Good morning, and welcome to WellPoint’s fourth quarter earnings conference call. I’m Michael Kleinman, Vice President of Investor Relations. With me this morning are Angela Braly, our President and Chief Executive Officer; and Wayne DeVeydt, Executive Vice President and Chief Financial Officer.
Angela will begin this morning’s call with an overview of our fourth quarter results, actions and accomplishments. Wayne will then offer a detailed review of our fourth quarter financial performance, which will be followed by a question-and-answer session. Ken Goulet, Executive Vice President and President of our Commercial Business and Brian Sassi, Executive Vice President and President of our Consumer Business, are available to participate in the Q-and-A session.
During this call, we will reference certain non-GAAP measures. Our reconciliation of these non-GAAP measures to the most directly comparable measures calculated in accordance with GAAP is available in our press release and on the investor information page of our company website at www.wellpoint.com. We’ll be making some forward-looking statements on this call.
Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of WellPoint. These risks and uncertainties can cause actual results to differ materially from current expectations. We advise listeners to review the risk factors discussed in our press release this morning and in our quarterly and annual filings with the SEC.
I will now turn the call over to Angela.
Thank you Michael and good morning. WellPoint had a solid performance in 2009 amidst a challenging economy. Today, we announced full year 2009 net income of $4.7 billion or $9.88 per share. This included an after tax gain of $2.4 billion from the sale of our PBM to Express Scripts, partially offset by $542 million in after tax restructuring-related charges, intangible asset impairments related to the PBM sale and UniCare membership decline and net investment losses.
In 2008, our net income was $2.5 billion and included net after tax costs of $377 million, resulting from net investment losses and asset impairment charges, partially offset by the favorable resolution of certain federal and state tax matters. Excluding these items in each year, adjusted net income per share was $6.09 in 2009, an increase of 11% from $5.48 in 2008.
Our adjusted earnings per share increased in 2009 as a result of significantly improved performance in our consumer segment, better than expected results in the capital management areas of the company and higher than anticipated favorable reserve development. Fourth quarter 2009 GAAP net income was $2.7 billion or $5.95 per share compared to $331 million or $0.65 per share in 2008.
On an adjusted basis, excluding the gain on sale of the PBM, restructuring charges, intangible asset impairment and net investment losses in each period, adjusted net income was $536 million in the fourth quarter 2009 or $1.16 per share compared to adjusted net income of $682 million or $1.34 per share in 2008. We had a solid fourth quarter in core operations, where results were inline with our expectations, reflecting actions we’ve taken to effectively manage our business through the current economic situation and for the long term.
Operating revenue totaled $60.8 billion in 2009, down 1% from $61.6 billion in 2008 as membership stood at 33.7 million members at year end, a decline of 1.4 million members or 4% during the year. The primary reason that operating revenue declined was the loss of fully insured membership. Some membership loss was planned, like our withdrawal from certain Medicaid programs, where we couldn’t get appropriate rates and some was economy related.
However, the membership volume declines were significantly offset by premium rate increases in each of our business segments. We price our business in an actually found and fiscally responsible manner and will continue to do so. Membership declined by $185,000 during the fourth quarter of 2009. Almost all of the fourth quarter enrollment decline occurred in the commercial segment and included a decline of $59,000 in the non-Blue business.
Our commercial employer based business continued to be impacted by in-group membership attrition, resulting predominantly from economic conditions. While sales and lapses were both favorable to our projections, we experience net negative in-group change of 180,000 commercial members during the quarter. The unemployment rate has begun to stabilize, but the number of out of work Americans remains very high and we did not expect the employment situation to improve until late this year.
If this happens and employers begin to rehire workers, we should see membership and top line revenue growth in 2011 and beyond. On a positive membership note, we ended 2009 with about 100,000 more fully insured members than we had planned, predominantly in our Blue Local Group business.
Our broad networks with significant discounts and excellent service offer employers the value they are looking for in this economy. This is one of the reasons that we continue to win in the marketplace, as demonstrated by our successful 2010 national account selling season. We had an outstanding sales year for National Accounts.
In total, we enrolled 31 new groups for 2010 with more than 400,000 net new National Account members on January 1. Adding expected gains in BlueCard membership, our total National membership will see nice growth again this year. We have an unmatched value proposition for this marketplace, offering access to the broadest provider network in the country; competitive unit costs; good customer service, innovative consumer-friendly products and tools and continuing initiatives to enhance both the cost and quality of healthcare for our customers.
Additionally, Medicare Advantage sales for January 1 were solid, and we’re off to a good start in 2010. We have a diverse membership base as a leading insurer of individuals and small groups in the country. The second largest Medicaid managed care plan, the fastest growing National Accounts carrier in the nation and a leading provider of senior products. This customer diversity helps reduce volatility in varying economic conditions.
We continue to introduce new benefit designs to the marketplace to meet the needs of customers and help ensure that our product portfolio is competitively positioned. During 2009, we introduced new, more affordable products in several key markets while also eliminating older, less popular plans to improve efficiency. We also continue to implement actuarially sound rate increases and find the marketplaces as competitive, but generally rational.
Competitors have raised rates in some of our key geographies, including California, which should benefit our sales going forward. Ultimately, all companies must price to cover their costs over the long term. We continue to price our business so that expected premium yield exceeds total cost trend, where total cost trend, includes medical costs and selling, general and administrative expenses.
For the full year 2009, underlying Local Group fully insured medical cost trend was 8.9%. This is inline with our most recent projection for 2009 and higher than the trends we experienced in 2008 due to increased business mix shift, including COBRA membership and elevated flu activity.
COBRA membership rose slightly in the fourth quarter and comprised approximately 2.5% of our fully insured commercial membership at 12/31/09. Unit cost increases continue to be the primary driver of medical cost trends. However, utilization rose in 2009 due to business mix shift, including COBRA and the flu.
As expected, our benefit expense ratio was 82.6% in 2009, 100 basis points lower than in 2008 due to improvements in our consumer segment, partially offset by increases in our commercial segment. Both our consumer and commercial segment benefited from higher than anticipated prior year favorable reserve releases that were not reestablished during 2009.
These totaled an estimated $262 million for the year and favorably impacted the 2009 benefit expense ratio by 50 basis points. The decline in the consumer segment benefit expense ratio was also driven by operating improvements in our senior business, primarily due to product portfolio changes and pricing adjustments in Medicare Advantage that were implemented for 2009, in addition to continued enhancements in our medical management program.
Results in the state sponsored business also improved due to strategic actions taken over the past several quarters, such as contracting changes and withdrawing from certain unprofitable programs. These decreases in the benefit expense ratio were partially offset by a higher ratio for Local Group business, reflecting the impact of the recession on business mix changes, including higher COBRA membership and increased flu activity.
We believe that the companies can effectively manage healthcare costs and do so with the lowest administrative costs will succeed in the long term. Consequently, in 2009, we launched enterprise wide continuous improvement initiatives, recognizing our loss of membership in 2009, and undertaking the strategic actions necessary to keep us competitive in the long term.
We recorded restructuring and other related charges in the fourth quarter of $102 million after-taxes in connection with these initiatives, which we expect to benefit our results in 2010 and beyond. On December 1, 2009, we closed the sale of the NextRx PBM to Express Scripts. We received cash consideration of $4.7 billion and recognized a pre-tax gain on the sale totaling $3.8 billion in the fourth quarter of 2009.
We also entered into a 10 year agreement with Express Scripts for PBM services that improves our competitive position in marketplace. The transition so far has been very smooth and we’re successfully migrating our pharmacy members to Express Scripts. We’re confident that our members will receive excellent service and greater value from this strategic alliance.
At year end 2009, our UniCare subsidiary exited the commercial market in Texas and Illinois. Marketplace dynamics made it increasingly difficult for UniCare to provide affordable, high quality products to commercial customers in those states. We know from our unsurpassed value proposition in WellPoint’s 14 Blue states that our plan must have sufficient scale to obtain optimal provider arrangement and deliver maximum value to commercial and individual customers.
I’d now like to turn to health care reform. Given recent events, it’s difficult to predict how health care reform efforts will evolve over the next several weeks. We continue to support responsible and sustainable health care reform that fundamentally address the costs and insures more Americans. In the ongoing consideration of reform, the goal of positively impacting consumers and employers by reducing healthcare costs and improving quality for individuals, families, and businesses, should be paramount.
We’re a diversified company and we’re taking steps to improve our business regardless of the outcome of health care reform. We continued to see the importance of our business and our industry in reducing costs and improving quality in healthcare delivery. Given the increase in healthcare spending as a percentage of gross domestic products the need to drive efficiency and effectiveness is obvious.
WellPoint is committed to reimbursement reform such that new methodologies are focused on value, cost, and quality as opposed to more traditional fee-for-service approaches, which primarily reward activity without regard to cost optimization or the realization of the desired health outcome.
For example, in Maine, we’ve negotiated an all-inclusive bundled payment agreement for many in-patient cardiac procedures. These bundles include all facilities services, all physician services, as well as ancillary and diagnostic care. Additionally, they contain warranties for readmission and complications.
In 2010, we’re seeking to expand the concept of bundled payments to other markets into a variety of both inpatient and outpatient procedures. Additional reimbursement reforms are focusing on Accountable Care Organization, Patient Centered Medical Homes, shared risk models, and benefit designs, which encourage members to receive care from those providers who are demonstrating a commitment to value.
An integral component of our reimbursement reform strategy hinges on engagement and transparency, where both providers and members are equipped with meaningful data and information regarding the relative quality and cost of procedures. Our desire is to empower and equip our members to be smart, informed consumers of health care and to establish provider contracts and reimbursement methodologies that reward and underscore this principle.
We are positioning our company for long term success and I believe we have both the right strategy and the right team to address the challenges and capitalize on the opportunities that will be presented for WellPoint and our members. We will continue to strive to excel a day-to-day execution and create the best health care value for our customers and greater value for our shareholders. Our value proposition remains second to none in our industry.
For 2010, while operating gain is expected to decline, we plan to effectively deploy our capital and currently project earnings of at least $6 per share for the full year. We intend to meet our financial targets, while continuing to provide outstanding service to our customers.
I’ll now turn the call over to Wayne DeVeydt, to discuss our fourth quarter financial results in detail.
Thank you, Angela and good morning. We had a very good fourth quarter of 2009 with net income higher than expected as we achieved a larger than expected gain on the sale of our PBM, benefited from a lower effective tax rate than previously anticipated, and recognized higher than anticipated favorable reserve releases of approximately $50 million in the fourth quarter that were not reestablished at year end.
Premium income was $14 billion in the quarter, a $306 million or 2% decrease from the prior year quarter, primarily due to fully insured membership declines, mostly offset by premium rate increases. Administrative fees were $953 million in the fourth quarter of 2009, down $23 million or 2% from the prior year quarter, primarily due to lower revenues in the National Government Services business, our exit from the Connecticut Medicaid program, and lower Local Group ASO membership, partially offset by higher commercial administrative fees per member per month.
The benefit expense ratio for the fourth quarter of 2009 was 84.8%, inline with our expectation and 140 basis points higher than the same period of last year. The increase in our Local Group benefit expense ratio is the primary driver. As we noted last quarter, the impact of the recession on business mix shifts and utilization patterns and higher flu expenses drove an increase in Local Group benefit expense ratio during 2009.
Our Consumer segment results improved year-over-year due to operational improvements we made in our Senior and State Sponsored businesses, which were partially offset by our higher individual benefit expense ratio. We recognized higher than anticipated favorable reserve releases of approximately $50 million in the fourth quarter of 2009 and this favorably impacted the fourth quarter ‘09 benefit expense ratio by 40 basis points.
For 2010, we have been pricing ahead of expected medical trend and based upon our limited experience to-date; believe we are appropriately pricing our products in an actuarially sound manner. Our most recent information shows that the average loss ratio of the groups we renewed was lower than that for the groups who lapsed for both large group and small group business. We estimate that our 2009 Local Group cost of care trend was 8.9%.
Medical cost trend continues to be driven by unit cost. Both, utilization is growing contributor, which we believe is mostly attributable to the flu and economy related factors, including COBRA. Inpatient hospital trend is in the low double digit range and is mostly related to increases in costs for admission. Approximately 90% of the inpatient trend is cost driven, while 10% is utilization driven.
Primary contributors to unit costs trend include elevated average case intensity, as well as higher negotiated rate increases with hospitals. Both the inpatient admissions per thousand members and the inpatient days of care per thousand members are higher than the prior year, continued clinical management and re-contracting efforts are in place to help mitigate the inpatient trend increases. Also, new pilot programs are being introduced for readmission management, as well as focused utilization management at high cost facilities.
Outpatient trend is in the low double digit range and is 65% cost driven and 35% utilization driven. Outpatient costs are a collection of different types of expenses, such as outpatient facilities, labs, x-rays, emergency room, and occupational and physical therapy. Per visit costs are still the largest contributor to overall outpatient trend, influenced by price increases within certain provider contracts.
Physician service trend is in the mid single digit range and is 55% cost driven and 45% utilization driven. Increases in the physician care category are partially driven by contacting changes. We are collaborating with physicians to improve quality of care through pay for performance programs.
Recent increases in utilization trends are driven at least in part by recent H1N1 flu activity. We were the first health plan to cover administration of the H1N1 vaccine and believe this will help hold down the incidence of more serious flu complications. Pharmacy trend is in the mid-to-high single digit range and is mostly unit cost related.
Recent inflation in the average wholesale price of drugs is applying upward pressure to the overall cost per prescription, as is the increased use of specialty drugs. We expect our new ten year agreement with Express Scripts to positively impact pharmacy trend as our pricing has improved.
Moving now to selling, general and administrative expenses, or SG&A, the SG&A ratio was 17% in the fourth quarter of 2009, an increase of 190 basis points from 15.1% in the fourth quarter of 2008.
The increase was primarily related to restructuring charges following a strategic review of our processes and structures, part of our continuous improvement program that is projected to drive greater efficiency and effectiveness in future periods. As Angela mentioned, we recorded a restructuring charge totaling $172 million pretax in connection with these initiatives that will yield savings in 2010 and beyond.
Turning now to our business segments, commercial operating revenue was $9.3 billion in the fourth quarter of 2009, $162 million or 2% reduction from fourth quarter ‘08, as commercial enrollment declined by $948,000 or 3% during 2009, reflecting the rise in unemployment. Operating gain was $317 million in the fourth quarter of 2009, a decrease of 57% from $728 million in the fourth quarter of 2008.
Fourth quarter 2009 results included costs of $127 million for our restructuring activity. The remaining decline in operating gain resulted from an increase in the benefit expense ratio for Local Group business and lower fully insured enrollment in 2009. Our Consumer segment operating revenue was $3.9 billion in the fourth quarter of 2009, $175 million or 4% less than the fourth quarter 2008, primarily due to lower senior membership from certain products we discontinued in 2009.
Operating gain for the Consumer Business segment was $159 million in the fourth quarter of 2009, a decrease of 33% compared with $236 million in the fourth quarter of 2008. Lower results in the individual business and costs of $24 million for restructuring activities offset continued operating improvements in our senior and state sponsored business.
In the fourth quarter of 2009, we recognized an impairment of $57 million for goodwill and intangible assets, primarily due to the December 2009 closing of the NextRx sale and our UniCare subsidiaries exiting the commercial health insurance markets in Illinois and Texas at year end. Also, during the fourth quarter of 2009, we recognized net investment losses of $5 million, consisting of other than temporary impairments totaling $41 million, primarily offset by net realized gains from sales totaling $36 million.
As of December 31, 2009, the company’s net unrealized gain position was $712 million, consisting of net unrealized gains on fixed maturity in equity securities totaling $501 million and $211 million respectively. This is a $1.5 billion improvement over year end 2008, when we had fixed maturity and equity securities that were in a net unrealized loss position of $567 million and $209 million respectively.
Turning now to our claims reserves, medical claims payable were $5.5 billion at the end of the fourth quarter, a decrease of $734 million from year end 2008, reflecting lower fully insured membership and faster cycle times. For the full year of 2009, we estimate that we recognized $262 million of higher than anticipated reserve leases that were not reestablished $181 million in the Consumer segment and $81 million in the Commercial segment.
During the fourth quarter, we recognized an estimated sales $50 million higher than anticipated favorable reserve releases that were not reestablished at December 31, 2009, $33 million in the Consumer segment and $17 million in the Commercial segment. As of December 31, 2009, days in claims payable was 42.3 days, 5.4 days lower than December 31, 2008 and a decrease of 4.1 days from September 30, 2009.
Approximately 1.6 days of the reduction in the third quarter related to favorable prior period reserve releases that were not reestablished at December 31, 2009, as well as faster payment cycles. The closing of our transaction with Express Scripts resulted in an accelerated payment of pharmacy claims and changes in the timing of these payments, reducing DCP by another 1.5 days in the quarter and the remaining decline of one day resulted primarily from medical benefit seasonality in the commercial and individual businesses, which experienced higher benefit expense ratios in the fourth quarter.
Our claims cycle times has improved in 2009. Since the fourth quarter of 2008, we have shortened our payment cycle time by 11% through the operational improvements. Payment cycle times represent the days of lapse between receipt of a claim and payment of the claim. In addition, as of the fourth quarter ‘09, we are receiving claims on average 1.6 days faster from the date of service than we were a year ago.
Since our claims cycle times have been dramatically reduced over the last year, the volatility in our claims is significantly lower and the acceptable actuarial range of values from which we establish reserves has narrowed. In accordance with good actuarial accounting practices, we continue to add a high single digit margin for adverse deviation. Thus, our claims reserves are established in a consistent manner and we believe, that at December 31, 2009, reserves are conservatively and appropriately stated.
Our reserves continued to develop favorably. We’ve included in our press release a reconciliation enroll forward of the medical claims payable reserves. We report prior year redundancies in order to demonstrate the adequacy and consistency of prior year reserves. In 2009, we again had significant positive prior year reserve development of $807 million. As expected, this level of positive reserve development was significantly higher than the $263 million we experienced for 2008.
Turning now to cash flow and capital deployment, cash flow from operations in 2009, which exceeded $3 billion, was greater than adjusted net income and approximately $500 million higher than in 2008. During the fourth quarter of 2009, we repurchased 16.5 million shares of our common stock for $827 million. For the year, we repurchased 57.3 million shares or 11.4% of our shares outstanding at the end of 2008, for approximately $2.6 billion at an average cost per share of $46.02.
During the first three weeks of January, we repurchased 3.1 million additional shares for $193 million. Yesterday, our Board of Directors increased the share repurchase authorization by $3.5 billion, and we currently have $3.7 billion of share repurchase authorization remaining, subject to market and industry conditions.
As of December 31, 2009, we had approximately $4.5 billion of cash and investments held at the parent company and available for general corporate use. We started the fourth quarter with $1.1 billion in cash at the parent; received approximately $3.3 billion at the parent company from the Express Scripts transaction closing; received dividends from our subsidiaries of $1.2 billion; utilized approximately $800 million on share repurchase; made interest and debt payments of $400 million; and added a net $100 million from other items including inter company settlements.
Please note, that we have approximately $1.2 billion of taxes to be paid in the first quarter of 2010 relating to the sale of our NextRx Subsidiaries with $300 million at the parent company and $900 million on the books of our subsidiaries. In terms of sources and use of parent cash for 2010, we started the year with $4.5 billion at the parent company; expect ordinary dividends of approximately $2.3 billion from our subsidiaries; have about $600 million of debt and interest payments; will pay taxes from the parent company of approximately $300 million; leaving cash available at the parent company of approximately $5.9 billion prior to deploying any capital to our shareholders.
We intend to deploy approximately $4 billion for share repurchases in 2010, subject to market and industry conditions. We routinely evaluate alternative methods for deploying capital to our shareholders and continue to believe that share repurchases currently are the most appropriate method, given our company’s cash generation and the earnings per share accretion potential.
Our debt-to-capital ratio ended December at 25.3%, down from 27.9% at the end of the third quarter. As Angela noted, we currently expect earnings per share of at least $6 in 2010, we believe that we have taken a prudent approach to our forecast for 2010, and will be providing much more detail about our 2010 plans at Investor Day on February 23, 2010. To register, please contact our Investor Relations Department.
I will now turn the conference call back over to Angela to lead the question-and-answer session.
Thanks Wayne. Operator, please open the queue for questions.
(Operator Instructions) Your first question comes from John Rex - JP Morgan.
John Rex - JP Morgan
So I wanted to turn first to kind of your commentary on the reserve position here coming out of the year. So you spoke about still being conservatively stated. The obvious metrics that we see in a GAAP financial, though, up cash flow, DCPs, etc., just don’t go in the right direction in terms of what we typically think about.
So I wonder if you can help us kind of clean that up a bit in thinking about the reserve position coming out of the year. Also, just kind of how you view gets the margin that you have built in to the current payables accrual?
I’m going to let Wayne take us through the math because I think that’s important, but keep in mind, I think we continue to be conservative in how we operate and also, keep in mind that we really had a good 18 months of improvement and 12 solid months of what I would call real stability in our transparency and clarity into claims and that, I think, has contributed to a continuous conservative reserving methodology, but we do need to explain DCP and we can specifically explain some of the cash flow issues. So Wayne, you want to go through each of those?
I think it’s fair to say that the two metrics can be very misleading over what we would typically expect them to indicate. So, let me address cash flow first, and then let me go into the DCP because it is affected by some of the cash flow items that are occurring. Just as a reminder for our listeners, we had guided for positive operating cash flow about $100 million in the quarter and that included us fully funding our employee pension plans in the quarter.
So, net of tax, we had a net cash outflow of operating cash flow of $130 million in the fourth quarter. Now that, again, was in our original guidance, but I wanted you to be aware that that did impact the cash flow for the quarter and you need to keep that in mind. The second thing though that is very relevant is we have three states that actually owed us approximately $100 million as of 12/31 and was fully expected to be collected in the last week of December, that actually came in the first week of January.
So we have collected it, but that $100 million is simply timing and we’ve earned the underlying income in the quarter, but we receive the cash flow in the first quarter of January. So when you actually add that in, the cash flow looks good and then the final item that is causing a cash flow anomaly is that when we closed the transaction with Express Scripts, one of the underlying terms we had was how their systems pay versus how our systems paid and essentially, simply put, the payment cycles moved up by one week over the next 10 years.
You get a onetime kind of hit, if you will, at the start of the contract and you pick up the benefit at the end. That onetime impact was $200 million, so our operating cash flow was impacted by $200 million just due to this onetime timing item. So, when you look at it from that perspective, cash flow was very strong. Another thing I would say is that if you pullout the ESI proceeds, which, as a reminder, those go into financing activities in our cash flow statement not operating.
So you have to bifurcate that because they don’t flow through operating cash flow. When you bifurcate that out, our operating cash flow net income is a very, very strong 1.3 times net income, even with these timing items occurring. So cash flow, we think is very strong for the company.
Now, relative to DCP, the ESI has the biggest impact when you think about that. The fact that you don’t change your numerator or change of denominator, but your numerator, meaning your claims payables being paid down $200 million faster, that’s what generates the $1.5 billion decline in DCP.
The other 1.6 day decline, as Angela said, is $50 million release of the reserves and then of course, the delta is we are paying claims much faster, but we’re receiving them 1.6 days faster and we’re paying them 11% faster. So ultimately, that is causing that impact and the other days the normal seasonality you see every year in the fourth quarter.
So, with that being said, I would say that I think cash flow is actually very good with those timing items and us fully funding our pension, but more importantly, as Angela said, John, I really believe that not only do we have the high single digit margin for adverse development established, but because of our conservative pick that we consistently make, there’s a reasonable possibility that we could be favorable, but as we’ve done with past practice, we will not included that in any guidance and we will spike that out as it actually occurs, but right now I do not believe and feel very confident we are not short.
Your next question comes from Justin Lake - UBS.
Justin Lake - UBS
My question is on the MLR trajectory in the fourth quarter. Clearly, you saw a pretty significant increase, sequentially about 300 basis points. If I look back over the last couple of years, that’s been closer to 100 basis points. So can you talk about what’s driving that increased seasonality? Then given the H1N1 costs, I think we all think came in lower in the quarter, what was the pressures that lost that benefit in MLR year-over-year despite the benefit and how do you see that playing out next year as well? Thanks.
We did obviously talk in our remarks about both the flu and the COBRA because we have seen increased COBRA membership and that’s reflected as well. We had talked the third quarter about flu ticking up, but then it frankly abated somewhat. So Wayne, do you want to talk a little bit about the business mix and the fact that COBRA is in that commercial MLR in particular?
Justin, the first thing is kind of the broader history repeating or is it actually getting worse. The reality is that over the last two years, we’ve seen the average deductible in our book in every segment, whether it would be individual, small group, etc. increased by 20% over the past two years.
So with that dynamic, you end up with lower MLRs through the first three quarters and you end up with a higher MLR theoretically in the fourth quarter and so that trend is just continuing. So last year they went up about 10%. This year they went up another 10% and so that is one factor that I would just say where history is not necessarily indicative of the future.
The second thing I would add, though, is if you recall correctly in our third quarter, the H1N1 spike we saw was in the Tamiflu being prescribed in the last two weeks of September. The actual doc visits and the actual claims associated with that did come through, and we saw a lot of that come through in October, so H1N1 was actually still very elevated in October. Now, it abated dramatically in November, December.
So we had the very high as expected for one month, much lower than expected for the next two. What offset the much lower than expected, though, is that our COBRA went from 2.2% of our book to 2.5% of our book in the fourth quarter. So in essence, we didn’t get what I would call a little more of the upside we maybe expected to see with the last two months of abatement because it was essentially offset by the COBRA.
While we’re talking about COBRA too, we often get the question about the subsidy around COBRA being extended for 15 months. We believe we priced for the higher COBRA membership and expenses through the 2010 pricing.
Your next question comes from Charles Boorady - Citi.
Charles Boorady - Citi
Just a couple things I’d like to hear a little bit more about. Angela, if you can characterize for us the kinds of conversations going on among the boards of Blue plans and whether health reform has maybe changed the opinion of some non-profits to reconsider conversion, and if you think we should expect heightened M&A among the Blues?
Then on NextRx, I was just hoping to hear a little bit more around how the conversions have gone. Any initial client feedback now that the 1/1/2010 period is behind us? Any service related issues you need to address? Also whether the G&A that we’re going to see in the Q1 is reflective of what to expect on an ongoing basis or if there’s going to need to be a handing off period of some of the expenses related to NextRx?
Charles, let me talk about the Blue plan question that you asked because I think it’s an important one. I clearly think the health care reform discussion gave us all an opportunity to understand some of the fundamental drivers that are important to this business no matter what happens. Namely scale, we need to have scale, we need to have the best discounts in the market and those are characteristics that we as Blue plans can share together.
That, as well as the UniCare transaction for us was a strategic one. We transitioned the membership in Texas and Illinois to another Blue plan. So we really think we’re working really well with our Blue plan partners, whether they are ready to do a transaction is yet to be seen, but I think the nature of the need for scale, the access that we provide to capital creates a great opportunity for us for the future and, clarity around health care reform or not necessarily having the same level of overhang, they spur us to have more opportunities in the future.
In terms of the Express Scripts transaction and partnership, I have to say we are just very thrilled with the relationship that we had with Express Scripts. They are an excellent organization, and our team and their team worked incredibly well together to get through the closing and we were very diligent together as a team throughout the closing and throughout 1/1. These guys are really professionals, and they were ready for every possibility, and we did not have a hiccup.
So those relationships are really going well. I think we’re really serving our customers well, and that was our focus for the transition, but we also have great opportunity that we haven’t yet completely reached with them around their Consumerology, their focus on the customer, their ability to get mail order penetration, and those are all things that we are working with them on now to serve our members for the future.
One thing I would add to Charles, your question on the G&A, “How that will evolve?” It’s a really good question, so I want to make sure that our listeners understand the impact on G&A. We will have bubble staff for this migration period throughout all of 2010, and the reason for that is that so first quarter will be kind of a reasonable run rate for purposes of this component throughout the year.
I don’t think you’ll see improvements till 2011 regarding the bubble staff. The reason for that is on the date the deal closed, we had to reprogram our systems to be able to handle all that membership, but over the next 12 months, we will be migrating that membership off of our systems to their systems.
So I would say for 1/1 enrollment, as Angela said, it’s been exceptional and it’s been well, but that’s partially because, we’ve got bubble staff and they’ve got bubble staff, and we wanted to assure there were no issues. So we will continue with that staff throughout 2010. I think in 2011, you’ll start to see some of those synergies then.
Your next question comes from Doug Simpson - Morgan Stanley.
Doug Simpson - Morgan Stanley
Wayne, I missed what you gave as your cash balance at year, free cash at the parent?
Doug, at 12/31, we have $4.5 billion at the parent at year end. I just, only thing I wanted to clarify which we did in our prepared remarks was, I wanted folks to recognize that the majority of the taxes for the PBM are going to be paid out of one of the subs we have, so that does not count. There’s only about $300 million of that $4.5 billion is actually going to be used for taxes for the PBM, the rest will come out of the sub. So if you look to kind of free cash flow available, it’s about $4.2 billion right now.
Doug Simpson - Morgan Stanley
When you talk about the $2.3 billion of dividends next year, is that after that $1.2 billion, or before it?
Yes, $2.3 billion of dividends, so if you were doing simple math, Doug, I’d say start the year with $4.5 billion. We would have ordinary dividends of $2.3 billion. Now, clearly, we will try for extraordinary we’ve done every year. We’ve been successful historically, but right now if you’re modeling, I would use $2.3 billion of ordinary dividends and then, of course, our uses will be, we have $100 million of principal payments, about $500 million of interest expense.
We are assuming that rates are going to continue to move up and that renegotiating the credit facility will result in higher costs in this new environment and then taxes for the PBM of $300 million, so total uses of $900 million. So again, if you do nothing, you’ve got almost $6 billion, $5.9 billion, to deploy at year end and then of course, right now, we plan to deploy roughly $4 billion.
Doug Simpson - Morgan Stanley
Of that $6 billion then, maybe I’m just missing this, but I thought you said you had to pay $1.2 billion in taxes in the first quarter?
Again, Doug, of those taxes, $300 million will come from the parent. $900 million will come from the sub that is below the parent, and we’ll use the inter company tax settlement to pull that money out. So I wanted you to know, if you want to look at it of that $1.2 billion going out, just recognize that there is $900 million not coming from this parent money.
Doug Simpson - Morgan Stanley
Can you just talk about the 90% of in-patient trend related to unit costs? What are your employer customers saying about this? Are they aware of that as a cost driver? Just specifically, if you look out 12, 18 months, what are you really trying to do to knock that trend down?
We’ve been looking at that and working with our customers on that. Part of what we’re seeing is we had more intensity or case acuity in in-patient, because the right cases are going to out-patient. So you’re going to see a little bit of that. Out-patient settings, we need to get the right procedures into those settings as well. We are working through a number of different medical management strategies though to focus on that higher case acuity, to look at the contracting issues, particularly whether or not we’re hitting outliers successively.
That gives us an opportunity potentially to review some of the contracting relationships and the nature of that; as well as some of our specific case management activities around certain disease states. We can take that, for example, our AIM technology and turn it to cardiology and other things. So we’re really getting at some of that higher intensity in-patient cases.
Your next question comes from Josh Raskin - Barclays.
Josh Raskin - Barclays
Just following up a little bit on that last question around medical management, I guess, we’ve talked for a couple of years now about improved contracting and new medical management techniques, and yet year in and year out, we’re continuing to see very high single digit medical cost trend and actual acceleration in recent years. So I’m curious, from the impact of the economy and all sorts of forces, whether that’s reform related or not.
Are your customers allowing you at this point to be a little more aggressive from a medical management perspective? Are we going to get back to more referrals and pre-authorizations and other sort of medical management techniques that may actually start slowing down the rate of costs and how long is this sort of sustainable at this 9% range?
Josh, I would say there were a couple of different levers and then I’m going to turn it to Ken to talk about, the customers’ viewpoint here a little bit. One is I do think that we do have a tailwind, meaning support for a more vigorous look at contracting and that often that relates particularly around hospital contracting to important network questions in terms of do we have a significant provider in the network, but the employer community is more interested than ever that we drive for value in the contract negotiation.
I would then turn to the medical management levels that you described, and we do have an opportunity, and we are frankly, focusing on how to drive more effectiveness through the medical management program and then there’s probably a third level that we talked a little bit about in our prepared remarks around really changing the reimbursement methodology to get to the right outcomes and we can’t kind of give up on that level either and go back to the traditional level.
Because that’s ultimately where we’re going to have the more breakthrough around making sure that we have more of a shared risk model or one that really produces the right outcome, which we believe will produce a lower cost overtime, but I would love for Ken and Brian, since they are here to talk about the customers’ viewpoint about that and their desire and willingness for us to focus on those medical management levels.
Josh, this is Ken. I’ll jump in first. I think Angela captured it pretty well, but a couple things I would highlight. On the customer and employer ability to support us in our negotiations and their tolerance for rate increases, they want to take as many actions possible to drive down the cost of care.
So in many of our more difficult negotiations, they’ve been more willing over the last year to participate as a Local Employer Group, in getting involved and giving their opinions in our negotiations with our facilities and we’ve had only a couple of ones hit the newspaper recently, but in each of those, our customers are supporting us in our activities and making sure we are working together to drive down the cost of care.
There more of willingness for driving down costs in other ways I would say narrow networks are getting an increasingly good look from our employer groups who have just refreshed our select network in California because of many of the requests coming in and I think we will see an increase in that over the years, not away to HMO and utilization, but more towards networks where we’ve have the products, we’ve had some utilization, but it’s picking up.
Then finally, just clinical programs, we had over 700,000 members buy into our integrated health program, which is our highest touch clinical programs going into 1/1, which is a sign that employer groups are willing to purchase and buy the more involved engagement models to help drive down utilization. So across the board, there is a willingness to partner together, both on the contracting side, the product design, and the clinical programs.
Hi, Josh. This is Brian. I agree with everything that Angela and Ken said. I think additionally within the Consumer businesses, affordability is obviously one of the key issues and managing medical management is one of the key levels that we have and I still think that we still have upside opportunity relative to becoming more efficient, making sure that we’re rolling out the tools that we have at our disposal such as RHI to focus our medical management activities on the right cases at the right time. So I think there’s as we continue that effort in 2010, we will see some upside opportunity there.
Josh Raskin - Barclays
I guess just as a follow up there, do you think that your efforts in your contracting are more aggressive in terms of incremental change on the medical management front than you’ve seen in prior years and I guess if you had to guess three years from now, do you think your medical cost trend is higher or lower than the 8.9% you saw in 2009?
I would say to the first part of that question, yes. We think we’re being more aggressive and we are getting better engagement through the mechanisms that both Brian and Ken talked about and our desire and expectation is to further have a positive impact on trend, bring the trends down and as I said, the third level being those more risk sharing related levels around accountable organizations that are responsible for output and give warrantees on readmissions, etc. That too, I think is going to make a meaningful change in terms of the future trend.
Your next question comes from Matthew Borsch - Goldman Sachs.
Matthew Borsch - Goldman Sachs
If I could just turn back to the fourth quarter trend and I know you’ve got a few questions here, but to the extent you can spike out where, in what geographies H1N1 had more or less impact? When you talk about COBRA and also the deductible impact, am I correct in presuming you are seeing that more strongly in your individual small group business? Then finally on the same broad topic, what was the experience like with Texas and Illinois in terms of the results you had there as you are exiting those markets?
Let me first address the back pocket of the question, which was around the COBRAs, and the deductibles and that. We’re really seeing nothing in the individual because again, these are currently employers that are leaving their group. So it’s basically small group and large Local Group.
What’s interesting Matt, is that I would say as it relates to the COBRA. I mean, those States that are having larger unemployment like California and Ohio, we are seeing more COBRA, but it’s more a function of the underlying employment levels than it is a function of what I would call adverse selection because of the state.
The second thing I would say is as it’s related to the flu. I would say all of our States got equally hit, but not all at the same time. So some States had the impact sooner such as Georgia, but as it started to spread across the U.S., we were no less tainted in any one State. I wouldn’t call it adversely higher in any one State either, though. I would just say they were all pretty bad as related to the H1N1 impact. I would also say though abated almost equally at the same time, meaning that everybody’s now down at a comparable level across our States.
Relative to the fourth quarter trend, again, a big part of what we said even in the third quarter was, we raised trend, primarily the original 100 basis points was pretty much exclusively due to H1N1 and due to COBRA or mix shift. As we said, COBRA and mix shift are hard to differentiate because they’re kind of one in the same that if you get more COBRA members, you’re getting some mix shift adverse selection, if you will and see they are a little bit fungible and a little difficult to bifurcate, but of that 100 basis point increase at the time, about 50% was H1N1 and about 50% was COBRA related.
Matthew Borsch - Goldman Sachs
On Texas and Illinois?
Matthew, the Texas Illinois question, the transition went very well with UniCare. The customers had really a very transparent transition. We beat our expectations on the number of customers retained through the transition with HCSC. Our providers and our partners that we worked with, we communicated up front; they were very aware of the transition and we would say the transition went without a flaw.
I think too, though Matt, with getting to the question about the UniCare membership, Matt, over the last couple years, we had a really experienced operator, Dennis Casey reports to Ken, came in and ran that UniCare membership and tried to really right size it, but it was a strategic decision to transfer that membership. We don’t have the scale. We don’t have the depth of the provider discounts that we have in other geographies and that was really critical.
When you look at 12/31, that UniCare membership is still in there, and we’re expecting about a 400,000 member decline to be reflected from the 1/1, essentially the transition of that membership. In terms of the quarter, we saw some of the membership loss come out of Texas and Illinois, but I think that performance of that book was pretty stable throughout 2009 because we had really right priced it over the last couple of years.
The difficult part, Matt, was we did not think we could continue without eventually getting adverse selection and having that happen relatively quickly. So I don’t think you’ll see a huge windfall in MLR next year because of it going away, but I would tell you that the pace of that membership in UniCare was declining. We were on a pace for adverse selection very quickly.
Your next question comes from Christine Arnold - Cowen & Co.
Christine Arnold - Cowen & Co.
You all had guided for an 82.6% aggregate MLR excluding any positive development here and you had $50 million of positive development, which means the MLR was higher than you anticipated in the fourth quarter. A couple questions here, one, was there any negative development related to prior quarters, or did you just see trend coming in higher in the fourth quarter and if so, where?
Then, I estimate your commercial MLR was up about 70 basis points. Is it reasonable to think you’ll get that back and then more because, you should just get that back as the 870,000 members transition to ASO, assuming they have like a 90% loss ratio? So can you talk to the commercial dynamics and kind of what you’re seeing?
The first part is absolutely what you’re stating and we are. I think while H1N1 started to abate, I think the thing still misleading, although is it was very, very high in October, very high. So I think in many people’s mind, we’re thinking it was a non-issue for the quarter. It was not a non-issue and overall, regular flu in the quarter was still elevated over normal.
So I think we had what I would call that dynamic occurring. Couple that with the fact that our COBRA experience in the commercial book went from 2.2 to 2.5 that was another dynamic, meaning you’re getting a little bit of a mix shift problem, but all that being said, I would say that we were pricing for that dynamic to occur. We had been pricing ahead of trend specifically if that was to occur.
So I think to your point of you should see the MLR come down and improve next year, the answer is, absolutely yes and by a reasonable amount in light of the fact that we’ve now priced for a level of COBRA. We’ve priced for what we thought would be some level of H1N1 to continue into 2010. If it continues at the abated level, that will be a positive thing, hopefully, but nonetheless, I think it’s very fair to say that we should expect the MLRs to come down.
Christine Arnold - Cowen & Co.
So is my math right? We’re up 70 to 90 basis points in ‘09; we should get just that back by eliminating the $870,000, so it should improve by more than 100 basis points?
I would suggest that we wait until IR Day, because then we’ll show you the ins and outs as well regarding what is shifting from ASO or from pulling share to ASO, as well as the impact of UniCare and other items, but your broad math of coming down is very much right, Christine.
Christine Arnold - Cowen & Co.
What about the history of it being up 70 to 90 in ‘09, just so I have the baseline right, please?
I don’t have that in front of me, so we’ll have to follow up on that.
Your next question comes from Carl McDonald - Oppenheimer.
Carl McDonald - Oppenheimer
I know you’re going to give more detail at the Investor Day, but just in broad strokes, with the loss ratio coming down in 2010, and the at least $6 earnings guidance. Is there something on the SG&A that we should be aware of? Maybe something related to the PBM transaction, where we’re going to see a more significant spike in SG&A in 2010?
No, I mean I think, as we’ve mentioned, Carl, we are going to make some investments there still. We mentioned before about a couple $100 million that we’ve got planned for to further migrate some of our systems. We did migrate a couple of systems this year again in 2009, and they were flawless. We did the ESI migration and that has gone flawlessly, but I think outside of that, I do think overall SG&A, you’re going to see come down in absolute dollars.
Not just because of the PBM going away, but we needed to right-size our organization relative to our membership. So those will be things that we will talk out about separately, but in general, I don’t think you’re going to see SG&A be elevated. It’s going to be just the opposite impact. I do think though that while commercial MLR is going to be down and other items, we’re not assuming at this point you will see any reserve redundancy repeating, which again, as you know, is part of our conservative position that we always take.
So when you’re looking kind of year-over-year on EBIT, I’m not sure if people are modeling for that to occur or not, but I do think that there might be a little bit of a difference on how much G&A will help next year versus how much MLR will help. So we’ll provide more guidance on IR Day.
Carl McDonald - Oppenheimer
So you’re making the point the commercial loss ratio should be down by some amount in 2010, but not necessarily as much on the consolidated loss ratio?
Correct, because your senior loss ratio is going to go up with the senior rate cuts that occurred and you should expect Medicaid to go up slightly. I don’t think we’re going to model for these wonderful windfalls we keep hearing about are going to happen with all this federal funding. So, we’re modeling that it’s going to be a much tighter environment than maybe people are anticipating.
Your next question comes from Scott Fidel - Deutsche Bank.
Scott Fidel - Deutsche Bank
First question is, if you just have an estimate for how much swine flu expense you ended up booking for the full year of 2009?
I’m looking around my team to see if I can get you an exact number. Well, here’s the difficult part, Scott. Nothing gets quoted as swine flu, and nothing is quoted as flu. So we have to use things like upper respiratory. We have to look at Tamiflu prescribed and assume that doctor visit was flu-related.
So the problem is, no matter what number I give you, it’s probably wrong. What I can tell you though are that we thought there would be at least 50 to 60 basis points of trend for that and that would equate to about 120 million. So if you wanted to try to gauge kind of an approximation, that’s about what it would be, but just, recognize that it’s very difficult for us to know exactly what flu is.
Scott Fidel - Deutsche Bank
Then just on a follow up, on the Medicare selling season, if you could talk about from a product preference, what you are seeing this year in open enrollment season in terms of migration and network products and then also just with the seniors that lost their private fee for service coverage last year are you seeing more of a bias towards them moving into network PPO products or are you seeing some of them retrench back into med supp?
Let me just say that I think we’re very pleased with how open enrollment is going through January. As we’ve talked about on the calls previously, 2009 we spent a lot of time reengineering the entire senior division, including our sales and marketing efforts and through at least January, it looks like we had a very good selling season; we anticipated that we would, so it’s really not upside because it’s baked into the plan, but through January, we had about 115,000 some odd sales, which is about twice our normal sales.
As we kind of look at how those sales break down, we are seeing good conversion from our private fee for service book in our 14 Blue plans two our PPO products and also in those markets where we have strong HMO offerings, like in New York and Ohio. So we do have what we call a Blue boomer strategy, which is really focused on conversion to network based products and it does look like that’s playing out as we expected it would.
Your next question comes from Kevin Fischbeck - Bank of America.
Kevin Fischbeck - Bank of America
I was just wondering, I guess you maybe talked a little bit about it briefly when you talked about system conversion; but can you give us a little bit more detail about what actually happened as far as the restructuring activities and where you’re going to be getting how that’s going to be driving the savings in G&A next year?
Yes, let me talk about that a little bit and I’ll pass it to Wayne to give a little more detail, we saw the membership decline, which we’ve described. We also had overhead that was covered by the PBM as well as UniCare and we needed to takeout costs associated with each of those elements. So in terms of the restructuring that produces these results, our other goal was to maintain and improve service levels throughout that process and I think we’ve done that effectively.
If you look at the organization, I think we have right sized the organization at all levels to address that specifically. In terms of how we are investing, though, for future efficiencies, as Wayne said, we actually had a couple of conversion migrations that reduced our number of systems throughout 2010. We have some run out on some of those systems, so through the beginning of 2011, but we are working through those and you are not hearing a lot about that, which is exactly what should happen. As well as, Wayne talked about our focus on getting the ESI transition pretty effective.
So, I think we were aggressive in our approach to get to the right organizational structure for the future. Now, as we look at migrations for the future, one thing is, we are investing in the people and the technology to make sure that those are flawless and that you don’t hear about those either and so, you will see that investment come through in terms of our 2010 SG&A because and we’ll talk more about that at Investor Day, but our goal was to make investments to make sure that as we took out costs, we did it without disrupting service to our customers. I don’t know if anybody wants to add to that?
Yes, the only thing I would say is of the $170 million or so to what Angela added, the vast majority, well over $100 million of that was right sizing for the sale of the PBM, the UniCare and then the overall membership declines and what we expect to see in 2010, but with that, you also then have facilities and locations that we would no longer need, and so there is a facilities related charge in there, which is about $25 million of that number and then there’s a small amount in there for contracts that we no longer needed to have, third party arrangements because of some of this membership that’s gone away and some of it that we sold.
So you have kind of what I will call one-time payment penalties. Those clearly drive run rate benefits for 2010. However, as Angela said, we’re using some of that to reinvest to further consolidate our platforms, make sure we have appropriate bubble staff that those are done seamlessly.
You will see though at IR Day and we will talk further, that our G&A is going to be improving dramatically, but I would also add that the real benefits are going to be coming in the years 2011 and there on as we go through some of these initiatives to put those through.
Kevin Fischbeck - Bank of America
So should we be expecting any more charges as the year goes on or is this kind of what you need to do to get the away for the next two years?
Right now for 2010, it is what we believe we need to do throughout all of 2010 that we’ve been able to put. So we would not anticipate at this point in time any charges in 2010 at all, related to our various activities that we’re doing.
Your next question comes from Ana Gupte - Sanford Bernstein.
Ana Gupte - Sanford Bernstein
My question is about the outlook for your Consumer Business, which was a meaningful contributor in ‘09, offsetting weak Commercial performance, if you will. The four drivers I identified in ‘09, I think you’ve mentioned is you exited some unprofitable products in MA. You exited States, where you were unprofitable in the State Sponsored business. You were very, very conservative and released a lot of favorable reserves, and possibly engaged in spread pricing in Part D. I’ve not got clarity on that.
So going to each of those in 2010, for MA, there’s some rate pressure. It’s not the biggest part of your business, but it’s a headwind. Medicaid, you just mentioned that the states may not be getting the kind of federal funding you are looking for. On reserves, you’ve continued to be conservative relative to others, but perhaps it looks like not as conservative as you’ve been last year.
Then finally, on the spread pricing, that’s going away, and I’m not sure how that’s playing out with your sale of PBM. So what is your outlook for the consumer margins and year-over-year operating earnings growth into 2010?
I think you’re correct. I think 2009 was a very good year for consumer. I think for a number of reasons, while we will continue to optimize each of those businesses, we are going to go backwards for 2010 in Consumer because of a couple of the headwinds that you identified.
In the Medicare segment and Senior, we had the MA reductions and just normal trend in that business, about a $400 million headwind. We’ve reduced that to about $100 million headwind, given a number of reengineering changes and product changes and pricing changes going into 2010. So we do know that that business is going to be impacted.
As Wayne mentioned, Consumer overall had about $181 million in favorable reserve releases that were not reestablished. So again, being conservative going into 2010, that’s not reflected in our numbers. Also, in our State Sponsored business, obviously that was a beneficiary of some of those reserve releases, but we have also offset a number of that with reengineering in that business unit. While that will go backwards somewhat, we do expect kind of solid performance.
Then an individual, we are challenged in that business similar to how we are in local business with the economy and unfortunately, we have not seen the up tick in membership, particularly because of the COBRA subsidy and that being extended. So, we do have some challenges, but I think what we were able do was reengineer each of those businesses and set the bar and the run rate at a much higher level than we have historically.
Of course, we’re going to talk more about that at IR Day, Ana.
Ana Gupte - Sanford Bernstein
One quick follow-up, on the $6 guidance you’re putting out there, are you baking in the full share repurchase that Wayne mentioned or is that a degree of conservatism that is being built in?
We have included that $4 billion of share repurchases in the $6.
Your next question comes from Matt Perry - Wells Fargo.
Matt Perry - Wells Fargo
Just a couple questions on pricing for 2010, can you help me understand whether or not you had begun to price for the potential industry fees that health care reform would assess on the industry starting in 2011? Had that kind of gotten into your price increases? Would you expect to continue to put that in even though reform is kind of uncertain? Then secondly, on the ASO side, we’ve seen kind of reported yields if we look at the income statement flat to down in ‘08 and then again in ‘09. Would we expect to see the same thing in 2010?
Let me address the first question because many people have asked us, “How did you plan for health care reform?” I would say we were focused throughout 2009 on execution and doing what mattered no matter what and we really refrained from getting the organization very focused and spinning around the potential changes from health care reform.
With some exceptions we did anticipate, as health care reform was kind of going through the process, that there could be some 2010 impacts. So we began the process of operationalizing, potentially, things like the fee and how we would do that.
Now, because of the change that we’ve seen in health care reform, while we think we were adequately priced for COBRA, adequately priced for trend going forward, potentially could cover a reduced sum that was being discussed around industry fees. We didn’t fully lay that out in all of our places where we’d have to file and do all those things. So as we look at health care reform, one of the advocacy positions that we continue to take is, these things drive higher costs for our customers.
So we have to be very mindful about the impact of that and clearly, the insurer fees would have driven higher costs for our customers and that, ultimately, is borne by them in their pricing. So essentially I think we were poised and prepared and had begun the work on that, but are really not going to add those potential fees in at this point going forward. In terms of the ASO yields, I think things are getting rational, but I’ll turn it to Ken to respond to that as well.
There has been pressure on ASO over the last couple of years, but it has abated some as our competitors have firmed up. It seems, while there is a competitive process, our fees overall are up. Also, what we’ll talk about at Investor Day is, ASO profitability enhancers that we’re working through that will help our yields and help the overall profitability of the ASO book in the future years ahead.
Your next question comes from Brian Wright - Collins Stewart.
Brian Wright - Collins Stewart
Did the PBM sale have any impact on the MLR in the fourth quarter, as far as lower unit prices on…?
It had a very nominal and actually would have been slightly worse just because of the way the economy worked. Our new deal with the new rates is really effective 1/1. So what we had was kind of a more neutralized rate structure in December, comparable to what we had before with our existing PBM. So our new rates all go in effect 1/1. So there’s actually no benefit to the MLR in the quarter.
Your final question comes from Tom Carroll - Stifel Nicolaus.
Tom Carroll - Stifel Nicolaus
Yes, just a final question here. The conversation as you know about managed care companies paying a shareholder dividend seems to be back on the front burner again. I guess with your strong cash flow and lots of liquidity, has this discussion perhaps taken on some greater importance at the board level this year?
Tom, we continue to have very fulsome discussions around our capital plan with the board, and that includes the possibility of dividend overtime. As we reported today, we expect to use the $4 billion in cash this year in share repurchases, both due to the PBM transaction and then what I would call our regular run rate essentially of $2 billion over the year for repurchases, but we are very committed to continuing to have the discussion about the right way to return capital to shareholders.
Dividends are very much a part of that conversation as well and we’ll keep you up-to-date on how that goes. As we anticipate changes in the future, we’ll continue to have that discussion.
Tom, we’re planning at IR Day to give a little bit of background about our capital deployment decisions, how they operate, the risk that we see, when we think a dividend is right, etc. So that at least shareholders recognize that this is being addressed regularly by our board and by management, but we also want to make sure people understand that there are always different risk with different deployment mechanisms. We want to make sure people understand those.
So, I want to thank everyone who was able to ask a question and apologize to those who we weren’t able to get into the call in the queue. So let me wrap up here. I want to thank you all. In closing, I want you to know that we are very confident about our future. There are opportunities and challenges from the current economic conditions and possible health care reform efforts.
We have both the right strategy and the right team in place to address the challenges and capitalize on the opportunities that will be presented. We plan to continue delivering value to our customers and our shareholders in 2010 and beyond. We will be providing much more detail about our 2010 plans at Investor Day on February 23, 2010 and to register, please contact our Investor Relations department. I want to thank everybody for participating on our call this morning and operator, would you please give the call replay instructions.
Certainly, my pleasure and ladies and gentlemen, this conference will be available for replay starting today, Wednesday, January 27 at 11 am, Eastern Time and it will be available through Wednesday, February 10, at midnight Eastern Time and you can access the AT&T Executive Playback Service by dialing 1-800-475-6701 for within the United States or Canada or from outside the U.S. or Canada, please dial 320-365-3844, and then enter the access code of 123543. Those number once again 1-800-475-6701 for within the U.S. or Canada or 320-365-3844 from outside the U.S. or Canada and again enter the access code of 123543.
That does conclude our conference for today. Thank you for your participation and for using AT&T’s Executive Teleconference. You may now disconnect.
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