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Health Net (NYSE:HNT)

Q4 2013 Earnings Call

February 11, 2014 11:00 am ET

Executives

Angie McCabe - Vice President of Investor Relations

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

Analysts

David H. Windley - Jefferies LLC, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Michael A. Newshel - JP Morgan Chase & Co, Research Division

Bo Brandt - Goldman Sachs Group Inc., Research Division

Joshua R. Raskin - Barclays Capital, Research Division

Sarah James - Wedbush Securities Inc., Research Division

Ana Gupte - Leerink Swann LLC, Research Division

Carl R. McDonald - Citigroup Inc, Research Division

Christine Arnold - Cowen and Company, LLC, Research Division

Operator

Good morning, everyone, and welcome to this Health Net, Inc. Fourth Quarter and Year End 2013 Conference Call. Today's call is being recorded.

At this time, I would like to turn the call over to Angie McCabe, Vice President of Investor Relations. Please go ahead.

Angie McCabe

Thank you, Ginger, and thank you all for joining us for a discussion of Health Net's fourth quarter and full year 2013 results.

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

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

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

Jay M. Gellert

Good morning. I want to begin by briefly reviewing our 2013 accomplishments and how, particularly in the fourth quarter, they set us up for 2014 and for 2015, when our new businesses will be fully operational.

As we entered '13, we focused on 3 key issues. One, improving margins in our commercial book of business; two, achieving improved rates and greater stability in our Medicaid business; and three, meeting our financial performance goals in '13 without recording any adverse prior year reserve development.

In addition, we knew we had to make necessary investments to prepare for the exchanges, Medicaid expansion and the duals. I'm happy to report that I believe we've achieved all our goals, driving significant improvement in '13 compared with '12.

Going into '13, we focused a great deal of effort on changes to our commercial book of business. As evidence of our success, the year-over-year commercial MCR improved by 320 basis points, and the gross margin per member per month increased 32.4%. These achievements were the direct result of our tailored network products strategy and disciplined pricing across the board.

The Medicaid MCR in 2013 also improved substantially compared with '12. Most of the improvement is a result of favorable rate actions, the reinstatement of California Medicaid premium taxes and the State Settlement Agreement. Going forward, we received annual rate increases for both the TANF and SPD populations, some of which took effect on October 1, 2013, and others on January 1, 2014.

It's clear from these developments that our State Settlement Agreement is working as intended, strengthening state programs for us and for the state. We recorded no adverse prior year reserve development in '13.

Consistent with our expectations, we ended '13 with approximately $209 million in cash and investments at the parent, and a low 23.5% debt-to-total capital ratio, which provides us with ample capital flexibility as we enter '14.

Finally, our G&A was higher in '13, as expected, driven by the investments we made to prepare for the exchanges, duals and Medicaid expansion, and as we continue to pursue a resolution to the scale issues we've identified.

We made it our top priority, particularly in the fourth quarter, to do what it took to get off to a clean start in '14, and that really paid off. As of yesterday, we enrolled approximately 315,000 new members, ACA related, approximately 165,000 through the exchanges and 150,000 from Medicaid expansion. Approximately 85% of our exchange enrollees who signed for 1/1/14 have paid their premiums, and approximately 70% of enrollees signed for February 1, '14 have already paid.

Medicare enrollment as of 1/1/14 was higher than expected from both new sale and retentions. We expect further growth from the exchanges throughout the first quarter of '14.

Taken together, this represents a strong enrollment start to '14, as we gradually ramp up to an expected 600,000 total new members by year end. Fourth quarter '13 results were affected by these transitions in a number of relatively minor ways.

As you know, California did not extend canceled individual policies. As a result, the commercial MCR in the fourth quarter of '14 (sic) ['13] was 40 basis points higher than the guidance we gave at the end of the third quarter. The higher MCR was due to a higher utilization in noninpatient areas, mostly among members who left us on December 31, '13.

In the fourth quarter, we spent approximately $4 million more than expected to support the onboarding of the better-than-expected exchange Medicaid and Medicare enrollment. The higher fourth quarter G&A was partially offset by a lower tax rate. $6 million of other income reflects the ACA reimbursement adjustment for Medicaid primary care services and related G&A. This was anticipated. This Medicaid adjustment and related G&A will continue throughout 2014.

In addition, other income benefited from a settlement payment related to a pharmacy services contract. Operating cash flows impacted by increases in government and other receivables.

We've already received more than $70 million in payments since December 31. While IBNR rose by $6.3 million sequentially, adjusted DCP decreased sequentially due to a $15.5 million reduction in claims payable and an accelerated claims paydown in anticipation of new members in January '14. Full year adjusted DCP increased by 1.1 days year-over-year.

These fourth quarter developments set us up for a strong '14. In '14, our guidance assumes: one, that G&A will remain high in the first half of '14, as we transition in new business; two, that approximately $30 million in '14 savings will come from a new pharmacy contract; and three, that a lower income tax rate in '14 will occur due to a $60 million tax benefit.

Within this bridge, I'd now like to discuss how our businesses will unfold in '14 and give some color about the effects of a full year of dual contribution and further Medicaid expansion on '15. You'll note that we've provided a more detailed guidance table in our fourth quarter earnings release. We believe that this more robust disclosure will help you better understand how our new programs will impact our financial performance throughout '14 and into '15.

We are projecting GAAP earnings per diluted share in '14 of at least $3. This represents an approximately 40% increase over '13 earnings per diluted share. In '15, we expect a full year's contribution from our new programs, particularly the Coordinated Care Initiative and further Medicare expansion, will more than compensate for a return to a normalized income tax rate that year. Specifically, we currently expect revenues from the CCI and Medicaid expansion to increase by more than $3 billion in '15 versus '14.

So let's now look at Medicaid expansion under the ACA. The expansion covers those whose income is below 133% of the Federal Poverty Level. Early enrollment results are positive, with approximately 150,000 new members enrolled in the expansion program through January 31, 2014, in California and Arizona. The enrollment growth for the 133% so far is consistent with our full year expectation of a 42% enrollment increase across all of our programs in the Medicaid business. This expectation also includes approximately 45,000 new enrollees from California's Long-Term Support Services program known as LTSS.

We believe PMPM revenues from Medicaid will increase by almost 50% in '14. This is because of the significant growth expected in 133% and LTSS enrollees. For these members, PMPM premiums are higher -- expected to be higher than in the TANF program, due to a much different risk profile.

We'll also receive additional premium for certain SPD members, where we will be responsible for their LTSS benefits. All of this should drive overall state health revenues to a level just above $5 billion. This would make Medicaid our second largest revenue generator in '14.

We anticipate that the '14 Medicaid MCR will be approximately 85.2%. We believe this is reasonable, given our high levels of capitation, case management expertise and present experience. As you know, we have state settlement protection in California for all these areas.

We're off to a great start in the individual health insurance exchanges under the ACA. Covered California, the individual exchange in California, is clearly the leader among exchanges. We also participate in Arizona and Oregon. Through yesterday, we've enrolled approximately 168,000 new individual members through the California and Arizona exchanges.

Our share in Covered California is currently approximately 17% statewide. But more importantly, more than 30% in Southern California largely due to the success of our targeted Silver product. We are pleased that our exchange strategy is working as intended. We're doing well in our -- the Silver product among subsidized populations and in Southern California. The enrollment news is a positive endorsement of our strategies. We expect that by year-end '14, our individual enrollment should increase by more than 135% compared with individual enrollment as of December 31, 2013.

We continue to pursue margin improvement in our nonexchange large and small group commercial business. Yields on January 1 renewals were strong. With pricing discipline paramount, we do expect to see some additional attrition in these segments through the course of '14.

We believe this pricing, along with a more favorable mix from the rapid individual growth, would generate an approximately 260 basis point commercial MCR improvement in '14 compared with '13. In total, we expect overall commercial enrollment growth of about 6% for the full year.

2014 will also see the launch of California's Coordinated Care Initiative or CCI. This include duals demos in L.A. and San Diego counties and, as I noted before, the LTSS program. We signed our dual contracts last month. And last week, we received notice that we passed all of our readiness reviews and can begin marketing this quarter.

As a reminder, in L.A. County, active enrollment begins on April 1, 2014, and passive enrollment begins in July '14. In San Diego County, both active and passive enrollment starts May 1, '14.

On these dates, beneficiaries will begin to enroll automatically on their birthdays. Because of this, we expect dual enrollment will build gradually throughout the year, reaching approximately 38,000 members at the end of '14. We expect to reach enrollment of approximately 100,000 by the end of June '15.

I'll point out here that last week, we received confirmation from the state as to our expected total enrollment opportunity of approximately 95,000 members in Los Angeles County.

The realized PMPM revenues for the duals will ultimately depend on the enrolled member mix, among many other factors. For guiding purposes, our current estimate is for revenues PMPM of approximately $2,100 and full year revenues in '14 of approximately $342 million.

We believe the reported MCR for the program will be approximately 87% for the full year of '14. It will be lower in the first half and higher in the second half, as we begin to build enrollment July 1. We expect the MCR by the fourth quarter to be approximately 88%.

In the Western Region segment, the dual results will be reported separately, beginning in the first quarter of '14. Based on the expected performance of all of our state programs, including the duals, we presently anticipate that the receivable resulting from the state agreement will actually decline by approximately $10 million in '14. It was approximately $64 million at the end of '13.

Now some brief comments about Medicare Advantage and Government Contracts. We expect our Medicare Advantage plan to do well in '14. Despite rate pressure, we believe our MCR guidance of 89.6% is achievable. Our guidance is based on certain revenue initiatives and our expectation that our better-than-expected enrollment mix coming primarily in Southern California counties, where we have the highest percentage of capitation members, will support the improvement. In fact, our expected revenue PMPM in '14 is only 1.5% less than our Medicare PMPM revenue in '13.

Turning to Government Contracts, which includes our TRICARE North contract, we expect continued, stable and predictable performance to continue in '14 and be consistent with '13. G&A costs will continue to be an area of focus for us in '14.

With start-up costs on all our new programs continuing in the early part of '14, and with the impact of $146 million from the health insurer fee, we believe the G&A ratio will be approximately 10.8% for the full year of '14.

As I noted before, we expect our tax rate to decline in '14 to 34%. And this will benefit net income by approximately $60 million. We currently expect that this benefit will be recorded in either the first or second quarter of '14.

The tax benefit and the tax rate I just described relates to our income tax. In the other quarters, we expect a tax rate of approximately 51%, a more normalized rate, given the non-deductibility of the health insurer fee.

Largely as a result of this income tax effect, we expect to see a shift in our typical earnings seasonality. In '14, we expect the distribution, first half to second half, to be approximately 55% first half and 45% second half. We also expect to have an average share count of approximately 77 million in 2014.

Given our year-end cash position, we have the resources to repurchase back this year. As I noted earlier, we see '14 as a transition year, as we ramp up new programs with the expectation we'll see greater contributions from them in '15. I've already mentioned growth in Medicaid expansion and the duals. We also expect to see continued growth in the exchanges and in core Medicaid business.

We anticipate leaner G&A in '15, as startup spending abates and our scaled efforts lead to G&A cost reduction. Because of these factors, we currently believe that earnings per diluted share in '15 should be at least equal to earnings per diluted share in '14. This outlook assumes the '14 income tax rate benefit will not recur, the health insurer fee will increase and Medicare Advantage rate pressures continue to persist.

In closing, let me say that, with a solid '13 behind us, we approach '14 aware of the challenges but excited by remarkable opportunities. These new programs will remake Health Net into an even more diversified company, with greater revenue and earnings balance among our businesses. I'll reiterate, approximately 37% of health care plan revenues, or approximately $5.3 billion in '14, is covered by our California State Settlement. We have been, and continue to be, a leader in alternative payment methodologies. Most notably, capitation.

In '14, we expect that 70% of our members will receive physician services by way of capitated contracts. This percentage is likely to rise in '15 and beyond. We see the opportunities arising from the exchanges as a validation of our tailored network strategy, and the way for us to sustain and grow our overall commercial franchise, both in existing exchanges and in emerging private exchanges.

At the same time, and as I've noted repeatedly at investor conferences, we continue to actively explore options to address our scale issue. We expect to have news on that front in the first half of '14. This is an exciting time for all of us. We look forward to meeting these new challenges and, in the process, improving the health and wellness of our current and expected new members. We believe that this is the best and most direct way to achieve enhanced shareholder value.

Angie McCabe

Ginger, we'd now like to open it up for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Dave Windley from Jefferies.

David H. Windley - Jefferies LLC, Research Division

Could you comment first, you went through the things that were included in 2015. I wanted to make sure that you were not anticipating any of the scale-related actions that you might take in that 2015 guidance outlook. Is that correct?

Jay M. Gellert

Well, at this point, we are -- we want to get final news on Medicare and a few other things. But I think there's some additional opportunities that we haven't fully baked in. I don't want to see that though as guidance. I think we were just trying to convey that we were confident that we could successfully deal with the end of that -- of the one-time tax benefit that we've talked about.

David H. Windley - Jefferies LLC, Research Division

Understood. And that you can deal with that without the help of, say, an SG&A outsourcing type of transaction?

Jay M. Gellert

Yes, I think that the point I'd make is that independent of that, but then we also have to evaluate some of the other issues which will be forthcoming, like Medicare and some of those things, before we make final guidance and direction.

David H. Windley - Jefferies LLC, Research Division

Okay. And I'll just ask one more on -- I think you talked in qualitative terms about rate improvements in California. I didn't catch the numbers, if you gave them. Could you talk about, I think you mentioned both TANF and ABD getting some nice rate increases. Could you give us those numbers?

Jay M. Gellert

We don't typically do that. But I think the key point is that the rates have been structured so they're consistent with the targets that are established in the settlement agreement.

Operator

The next question is from Kevin Fischbeck from Bank of America Merrill Lynch.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Just want to confirm the comments you made. I think you said that you expect that you're not going to be dipping into the California Risk Share Agreement in 2014. And in fact, that you will earn, I guess, in excess of the target margins, so there will be a $10 million reversal. Did I hear that correctly?

Jay M. Gellert

That is correct.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay, is there one piece of the business where you feel like that, that margin target specifically will be above the target margin, or is it broad based?

Jay M. Gellert

No, it's broad based. I think if you look at the agreement in total and it reflects to me the fact that the state is moving the rate setting process in alignment with the agreement.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then the commentary within the commercial book about the tailored network business growing as a percentage, I guess, with total commercial down 12%. It looks like tailored network membership was down about 4%. So I mean, how do you -- I guess, is that right? And if it's right, how do you think about the value proposition of that business in your markets? It doesn't seem like that's a business that's strengthening maybe as well as we had hoped.

Jay M. Gellert

In fact, for January of 2014, for our California business, we'll have 54% of all commercial members in tailored networks. By the end of '14, we see that we'll be in the high 50s, low 60s in that regard. So I think the conversion that we've anticipated is going forward at, if anything, a little more rapid pace than we thought. This is really a transition year, I think, for ourselves and for the entire industry, in terms of the way we look at network. And we're beginning to see the same kind of activity in our other markets.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay, that's a big shift. That's -- that makes a lot of sense because my last question was just going to be on the commercial MLR. Just trying to get a little more color about why it's going to be down so much. Is it mostly this tailored network shift? Or is there anything else that you'd point to specifically?

Jay M. Gellert

Well, it's a combination of things. One is, bear in mind, there's increased pricing that's consistent, also what we said on the earlier calls, which covers the premium tax, but doesn't cover its deductibility. Secondly, we have lower unit cost trends. And third, I mean, and related to those unit cost trends is your point that we do have lower unit cost trends as we move to more and more tailored network products. And then, finally, we have the combination of the effect of the pharmacy initiative, which I earlier discussed, plus the fact that the cost of reinsurance is reflected in terms of G&A charge and the contract for reinsurance is reflected in MLR. So it's a combination of those things that lead you there, probably half rate and half the amalgamation of the other things I articulated.

Operator

Your next question is from Justin Lake from JPMorgan.

Michael A. Newshel - JP Morgan Chase & Co, Research Division

Mike Newshel in for Justin. Can you go over what is included in 2014 guidance in terms of premium tax? Are you assuming a full reimbursement from Medicaid, and if you're assuming a negative impact still for commercial, can you quantify that?

Jay M. Gellert

We indicated in our last call that we thought we would be able to cover the insurer fee in Medicaid, that we could cover the insurer fee, but not the deductibility in commercial, and that we were able to cover it in terms of our Medicare framework. So that hasn't changed. I think we're still exactly there in terms of our view of the ability to deal with the insurer fee.

Michael A. Newshel - JP Morgan Chase & Co, Research Division

Okay. And aside from the uptick in utilization, you called out on the individual book. Can you talk about what you're seeing in cost trend and what might be assumed in 2014 guidance?

Jay M. Gellert

In terms of unit cost, we're seeing improvement in the order of 50 to 100 bps. As I indicated in last discussion, it's partially a result of the bigger concentration in tailored networks, and it's partially actually the result in some let up in the contractual side. So that's what we're seeing. We're anticipating utilization to be constant or probably, even maybe a little up. On the other hand, the utilization that we saw, except for these kinds of one-time things, actually, was going down a little in the second half of '13. So we think there's a little utilization cushion in what we projected.

Michael A. Newshel - JP Morgan Chase & Co, Research Division

Okay. And last question, for your capitation agreements. Are there any capacity issues there, given all the membership that you expect? And also, are you using capitation agreements for the duals?

Jay M. Gellert

Let me -- in terms of capacity, actually, we have a lot of people who are even not in our network at this time, who now want to come in. I think there's an increasing recognition that the ACA is here to stay, and that we all have to work together to do it. We have actually some providers who are concerned that they want to get enough volume so they can actually build a business around this exchange structure. There are going to always be some transition disruptions. But we've not had core accessibility issues despite that. One of the things we did a lot in the fourth quarter was really work on that. One of the reasons that the fourth quarter, I'd say, had a little bump, was we had, I would say, overstaffed in recognition of the bumpiness that occurred. That's, I think, why we would have a relatively seamless transition. So I think that we're confident, that we have providers, and that the particularly important thing is making the front end investment to assure that you have a viable transition. With regard to the duals, we'll, on the next call, be able to give you the specific numbers. But by far, the majority of relationships in terms of the duals will be on a capitation basis.

Michael A. Newshel - JP Morgan Chase & Co, Research Division

And fully capitated for those individuals?

Jay M. Gellert

They'll be largely fully capitated for the medical side, in different kind of arrangements for the long-term care side, and those are the ones that will vary some. But I'll be able to discuss that in a lot more detail on the next call.

Operator

The next question is from Matthew Borsch from Goldman Sachs.

Bo Brandt - Goldman Sachs Group Inc., Research Division

This is Bo Brandt on for Matt. Just had a question on the Arizona market and wanted to know if there's any update or detail that you could provide.

Jay M. Gellert

Yes, actually, I think that '13 saw some good improvement in Arizona. And we're encouraged that the strategy which we set up in Arizona, which is really to try and drive it to be more like the Southern California market in terms of our business relationships, is moving forward pretty well. We actually now are seeing some other options in terms of moving to a California-like structure in Arizona. So I think in terms of economic performance, we've made the improvements we've articulated. And even probably more importantly, we've built out Medicaid and we are in a position where we see some real fundamental opportunities to redesign the delivery system.

Bo Brandt - Goldman Sachs Group Inc., Research Division

Great. And then on TRICARE. Are you expecting earnings growth in 2014? And if so, how much?

Jay M. Gellert

I think that we're expecting it to remain flat. There may be some opportunities, but we've been conservative in terms of our expectations at this point in time.

Operator

Next question is from Josh Raskin from Barclays.

Joshua R. Raskin - Barclays Capital, Research Division

First question, just on your exchange lives. What is your expected MLR, I guess, sort of fully baked in for the exchange lives?

Jay M. Gellert

Mid-80s.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. And then -- so that includes the reinsurance, et cetera?

Jay M. Gellert

Yes.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. So your commercial MLR of 83% is coming down 260 basis points. And that's inclusive of, I guess, what would be a higher MLR in the exchanges. Is that fair to say?

Jay M. Gellert

It's probably, at this point, conservatively estimated at 100 bps better, yes.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. And then you're -- so I assume, in the mid-80s, you're assuming that you are profitable in these exchange lives?

Jay M. Gellert

We've indicated that we've priced the exchange to breakeven. So breakeven fully loaded. I've said that before.

Joshua R. Raskin - Barclays Capital, Research Division

Got you. And then just shifting topics to the California duals. The PMPM you mentioned, I think $2,100, that sounded a little bit lower than what the rate expectations, or at least the state had published at close to $2,500. So I'm curious if there's a geographic or a mix issue there that's causing you guys to come in a little bit lower. And then on the membership side, we're just doing the math. And I think, when you look at sort of your fair share, let's say, $95,000 in L.A. County and maybe another, I don't know, $95,000 plus maybe another 13,000 in San Diego, and I know they've sort of come in. It looks like you're assuming, and I don't know if I'm off here, but are you assuming like 1/3 of these members actually opt out? Is that what's creating the difference? I mean, it just seems like the duals number was a little bit lower, both on the PMPM and the membership side.

Jay M. Gellert

Yes, I think, at this point in time, until we kind of complete this process, we just decided to take a more conservative outlook on the duals. Everything you said, I could show you a model that's consistent with that. But our expectations, at this point, I think, were to be conservative as we guide into this year.

Joshua R. Raskin - Barclays Capital, Research Division

Okay, all right. That's very conservative. And then, just last question on MA, it looks like your revenues are up a little bit more than your membership. So is there a mix impact there as well? Or are you actually expecting positive yields in 2014?

Jay M. Gellert

No, we're expecting negative 1.5% yield in 2014. That's, I think, higher than many because of 3 things. One, it is a mix difference, more business in Southern California, which has higher rates. Secondly, we've traditionally, I think, trailed in some of the risk adjusters and some of those things. So we have some -- we've built some initiatives in. And then, finally, I think we had an opportunity to raise some of our premiums in some other markets in conjunction with providers and we've been able to retain business doing that.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. And that's why you think the MLR will be down about 100 basis points?

Jay M. Gellert

Yes, I think it's more of the success of the revenue efforts and then the kind of -- then the greater number of capitation arrangements than it is anything else.

Operator

Your next question comes from Sarah James from Wedbush.

Sarah James - Wedbush Securities Inc., Research Division

You've talked about not covering the non-tax deductibility portion on the commercial book. So I just wanted to understand, is this across all products or just one segment, like the large group? Because if it was across all products, I was getting it to be close to a $0.30-or-so headwind. But if it was just large group, closer to $0.02. So I just wanted to make sure I understood that.

Jay M. Gellert

It's across all lines. We've indicated that we would not be able to cover the tax deductibility of that. So that is correct.

Unknown Executive

No, just commercial lines.

Jay M. Gellert

Yes, I'm sorry, it's all commercial lines.

Sarah James - Wedbush Securities Inc., Research Division

Okay. And then I wanted to clarify in your exchange statement on pricing to breakeven. Several of your peers have come out saying they initially priced to breakeven or a small profit, but now expect a loss. So are you saying that you priced to breakeven and continue to expect breakeven? Or that you've priced to breakeven and don't want to provide an update at this time?

Jay M. Gellert

No, no. I think that -- we've had this discussion on other calls. And you've raised a really important point. We've always felt that California market will differentiate itself from other markets in terms of the way the exchange will work. We felt it for 3 fundamental reasons: one, California didn't extend; two, that there's a large enough group of people in the exchange and the individual market because, bear in mind, the risk adjustment methodology crosses all ACA-compliant products; and three, that we've been able to develop HMO-based and more tightly managed and tightly networked products. So some of my colleagues, I think, are in states where none of those phenomena are true, that they have a disproportionate number of people who have been excluded from the market rather than people who didn't have the income to participate in the market. And I understand that point in those markets. I believe that what we've seen in California, let me just give you a few facts with regard to that, we kind of made some very specific statements about what we needed to see for the California exchange to work. And I'm going to give you those data because I think they're important. We said we had to be Southern California-based. We're 93% Southern California in terms of our business. We, as I said, have a 30% share in Southern and 2% share in Northern. We've said we needed subsidized people. We're 85% subsidized. We said we needed higher silver performance and lower bronze performance than was anticipated. We're actually 10 -- approximately 10% higher in silver and 10% lower in bronze. So I think that the points a lot of people have made are very, very valid. But I tell you, I think that this is very much a state-by-state phenomena. Additionally, and I think this is the final point, I guess, I'd make, is that I think that the key to all this is having a large enough pool, having a large enough number of people who are entering because they've been -- have income barriers rather than health status barriers and having a delivery system that is tight enough that you can actually hit the premier numbers. And I think we feel now comfortable we've had all those.

Operator

Your next question comes from Ana Gupte from Leerink Partners.

Ana Gupte - Leerink Swann LLC, Research Division

The first question, just to follow up again on the exchanges and the risk adjusters. It seems like there's a lot of variability in what the various competitors that you have were saying in terms of timing. On the risk adjusters, and even risk corridors and reinsurance, all the way from your pricing and positive margins, including everything to nothing is going to accrue. So where are you coming out on that? And if that was baked into guidance, is that including the risk adjusters as well?

Jay M. Gellert

Well, first of all, that is all under review. And I think it's premature to make a final comment on what the right treatment is. I will say, though, that the key element is the corridor because it basically, for all intents and purposes, makes the effect of the other 2 elements 20% to the degree you're in the risk corridor. Also, I think that the specific discussion of how the reinsurance is going to be paid out is something we've been fairly conservative about. We've not assumed, as some have been talking about, that the full $10 billion that's been collected is actually going to paid out. So we think, among all that, that we're in a -- we feel pretty comfortable with our position, but we're still awaiting guidance on some of the specific issues.

Ana Gupte - Leerink Swann LLC, Research Division

Okay. So just following up again then on exchanges and just the commercial loss ratio. You made a point about not having negative development in 2013, but you are seeing some high cost claims or some creep in utilization in the individual market. Do you feel comfortable at this point that the claims inventory has run through enough that you may not see any negative surprises? And what time frame in the first quarter would you say that there isn't anything in 4Q? And then, just a follow-up. Through the year, are you expecting as some of the smaller groups come up for renewal later in the year, that they might choose to dump or whatever, and then you again have pickup in utilization all the way at least through March, and maybe later in the year? I know some device analysts and all are making assumptions on favorable impacts for them.

Jay M. Gellert

Well, let me start through that. First of all, I think we -- that in terms of a continuation of the people I refer to, since California allowed no extensions, we can be much clearer on who's staying and who's going. Secondly, the tail issue's a very important issue, which you raised, and the good news for us in that context is the utilization changes have been primarily pharma and -- are entirely pharma and outpatient, and those claims come in quicker. The risk is that you have inpatient drag, and we've been monitoring that very closely, both for that specific group and in its entirety. The final point I'd make to you is that the January claims are very low. Now we think that that's partially because of the disruption, and we've not factored that into our analysis. But they have -- there appears to be continued evidence that it goes kind of the other way in terms of what we're seeing January and up until now in the middle of February. So I think all of those factors give us comfort in what we're doing. With regard to what's going to go on later in the year, I don't think I've yet factored in [indiscernible] online and I don't know the meaning of so that's really half, [ph] yesterday's announcement and its implications for what people are actually going to do. My sense is that will give an increased ability to the small group market. But honest to goodness, I haven't really thought about it in adequate detail to comment.

Ana Gupte - Leerink Swann LLC, Research Division

That's helpful. One final question, and I agree with you on the small group. It seems more likely to be favorable than not, but -- and it's hard to tell.

Jay M. Gellert

Too early to tell, though.

Ana Gupte - Leerink Swann LLC, Research Division

Yes, it's -- if you guys have any color on that as you go along, it'll be very helpful to know what happens. On Medicare, any thoughts on the CIGNA commentary about -- sort of hinted at coding creep cost per claim. And I'm speculating it was with capitated providers, maybe as they were pushing through sequestration pressure. And since you have a largely capitated book, does that balloon kind of pop up somewhere else? And as underfunding continues in '14, might you see more of that manifest itself for the rest of the group as well?

Jay M. Gellert

Well, let me first -- I only read a little bit of the CIGNA commentary. So I don't want to -- let me check with you. I thought I read it was the non-capitated providers because you wouldn't have coding creep in capitation because you have a fixed economic arrangement. So my sense in reading what CIGNA said is it was that they were doing pretty well, where they had tightly managed units and that where they didn't, that that was their real problem. Isn't that right?

Ana Gupte - Leerink Swann LLC, Research Division

It's hard to tell. I should probably again ask them. My sense is it's vertically integrated, because CIGNA owns some docs. And I kind of thought it was because they're mostly all capitated, but then they also own [indiscernible] and some other areas.

Jay M. Gellert

Yes, we've not seen either -- we've seen no similar pressure on the capitated side. And quite frankly, in the last couple of months, we've seen really some, a little bit more favorable inpatient trends on the Medicare side. They're still too early to tell and we're not calling them at all. But we don't see the creeps that they saw.

Operator

Next question is from Carl McDonald from Citigroup.

Carl R. McDonald - Citigroup Inc, Research Division

Could you talk about your loss ratio assumptions for the 40% growth in the Medicaid business? So just thinking about the new members there joining as opposed to the legacy?

Jay M. Gellert

Yes, yes. Well, in doing that, I think that the state have developed rates for the expansion population that are actuarially sound. Historically, our problem's been that we start low and end up in trouble and we have to fix it. I think now, because of the combination of some really good work that was done in terms of really looking at the mix, plus the relatively better state financial circumstances that I think are, we have a higher level of comfort with the new population, than -- in terms of the 133s, than we've had with older populations with the state. I think it's also a phenomena of the risk-sharing agreement, because it makes it more sensible to do it right upfront. Secondly, in terms of the LTSS population, they're a relatively small portion of the overall growth in 2014. We've had a higher MLR assumption with regard to the LTSS population. And to a large degree, there's a significant risk corridor arrangement for the pure LTSS population that kind of almost fixes the MLR. So when we look at it, we feel pretty good about that. Now bear in mind that we have 3.5% to 4% of premium tax in that. So that, in effect, the MLR we're talking about is an 88% MLR with that kind of arrangement built in. So it's not as aggressive as one would think absent the premium tax. And the premium tax from the state is basically considered in establishing the rates. So we're really talking about an 88% MLR with, I think, intelligently developed 133% rate with separate risk corridor protection for the LTSS, independent of our other arrangement with them. So we feel pretty confident that the rates are solid. And as I said that the SPD and TANF rates are built around sound assumptions in our view at this point in time.

Carl R. McDonald - Citigroup Inc, Research Division

And do you have a sense of how much of the Medicaid growth is coming from people previously uninsured versus -- I know there were some changes in some programs that had people shifting out of maybe Healthy Families into Medicaid?

Jay M. Gellert

Yes, the Healthy Families shift has already occurred. So there's probably 3 issues in terms of expansion of Medicaid in California and in Arizona. The 133s, very few of them were previously covered by Medicaid because they weren't eligible. So they were -- now in California, there was a separate waiver program, which was a transition to reform program, which included statewide, 600,000 people who that probably represent about 150,000 plus or minus, of our people. Those people are previously getting covered in that waiver program. And so they're being transitioned. They weren't uninsured. With regard to the LTSS population, they were all covered by the state. And with regard to the LTSS addition to SPDs, obviously, they were previously covered. So I would suggest that the 133s in the transition waiver, which probably represents about half of them, were previously covered. The remainder of the 133s I would -- weren't covered by Medicaid. But we have a lot of churn in that population, and everyone else was covered.

Carl R. McDonald - Citigroup Inc, Research Division

Got it. And then the other question I had was just on the California settlement agreement. I think the assumption coming into the year had been that you wouldn't have to rely on that in '13 and ended up being about $64 million. So just be interested in sort of what the major variances there were.

Jay M. Gellert

Yes. Yes, I think we indicated, in fact, that we would have to rely on it in '13 for 2 reasons. One, the rate increases we received before the October, rate increases in January, rate increases are more inadequate to hit the target. And I think we've said that pretty consistently. In fact, that's why we negotiated 75% protection because there was a recognition of that as we were negotiating the agreement. In addition, we indicated there were going to be significant start-up costs in terms of the 133s and the duals that were going to be handled through the settlement agreement. So I think that where we ended up, plus or minus 10, is exactly kind of where we thought we'd be. And that in the fourth quarter of that, we had more kind of, what I guess I'd say, administrative cost covered by the agreement because of the higher level of 133 involvement and the greater need to prepare for the duals.

Carl R. McDonald - Citigroup Inc, Research Division

Got it. And sorry, one quick one. How much of a benefit was there in the fourth quarter to other income from the pharmacy settlement?

Jay M. Gellert

It was -- it's kind of a combination. And I think what I understand is I'm not allowed to disclose it. [indiscernible] confidentiality agreement in terms of it, so let's leave it in there. But I can -- you do know that 6 came from the other thing.

Operator

Your next question comes from Christine Arnold from Cowen.

Christine Arnold - Cowen and Company, LLC, Research Division

A couple of just clarifying questions. The revenue initiatives in Medicare Advantage. So you're assuming that you're going to get a benefit from coding, even despite the fact that CMS is constraining a lot of codes? Can you help me understand.

Jay M. Gellert

I can, I can. Actually, it's fundamentally experience we've already had. We were trailing, and I think we've kind of gone through the process. In addition, though, what we found is that we have a higher level of acuity in some of the new markets than in the old markets we left. So that the combination of those things. So it's not counting on the future. It's really based on the experience we had entering the year.

Christine Arnold - Cowen and Company, LLC, Research Division

Okay. And then your expectation of profitability for on exchange enrollment, that 85% MLR that you think you're going to get there, are you leaning on the risk corridors to get there? Or do you think you won't need the risk corridors because things are coming in exactly how you expected?

Jay M. Gellert

I think that there -- I got to get an answer to this -- let me get this clear. At this point in time, we think that we're basically up against the risk corridors, but not in them. So we have protection. If the risk of being off is not great, but we're not counting on them for the number we have.

Christine Arnold - Cowen and Company, LLC, Research Division

Okay. And then do you have a sense for a bunch of high-risk pool members were kind of set loose with this whole process. How are you factoring that into your thoughts? Or do you think they went elsewhere?

Jay M. Gellert

No, I think that we've combined -- we've built them into some of our thoughts as part of what we've had in our plan. But we do believe we won't get a disproportionate number of them because of the tighter networks we had. So I think we've built in that we get a relative number of them. The other thing I guess I'd say, 2 other things I'd say, is that, bear in mind that, again, we've got 85% in HMO products. So that's a key. And secondly, that the work that we've done and the work that Milliman, I believe has done, shows that if you -- that risk isn't against you, it's risk in high-cost places that actually the risk adjusters are biased the other way. The studies that we saw that the accounting actuaries did said that actually no conditioned people you lose on and conditioned people you actually -- they actually showed a margin. So the key for us is not to get a disproportionate number of people with higher cost than their actual conditions in non-managed systems. And I think that's what we factored into our expectations.

Operator

This does conclude our Q&A session for today. And this does conclude the call. Thank you for your participation. At this time, you may now disconnect.

Angie McCabe

Thanks a lot.

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