Aetna Q1 2010 Earnings Call Transcript

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 |  About: Aetna, Inc. (AET)
by: SA Transcripts

Aetna (NYSE:AET)

Q1 2010 Earnings Call

April 29, 2010 8:30 am ET

Executives

Mark Bertolini - President and Head of Business Operations

Ronald Williams - Chairman, Chief Executive Officer, Chairman of Executive Committee and Member of Investment & Finance Committee

Kim Keck - Vice President of Investor Relations

Joseph Zubretsky - Chief Financial Officer and Executive Vice President

Analysts

Ana Gupte - Sanford C. Bernstein & Co., Inc.

Joshua Raskin - Barclays Capital

Charles Boorady - Citigroup Inc

Justin Lake - UBS Investment Bank

Carl McDonald - Oppenheimer & Co. Inc.

John Rex - JP Morgan Chase & Co

Scott Fidel - Deutsche Bank AG

Christine Arnold - Cowen and Company, LLC

Operator

Good morning. My name is Beth, and I will be your conference operator today. At this time, I would like to welcome everyone to the Aetna First Quarter 2010 Earnings Conference Call. [Operator Instructions] We will begin by turning the call over to Ms. Kim Keck, Vice President of Investor Relations and Treasures. Ms. Keck, please go ahead.

Kim Keck

Good morning, and thank you for joining Aetna's First Quarter 2010 Earnings Call and Webcast. This is Kim Keck, Head of Investor Relations and Treasures for Aetna. And with me this morning are Aetna's Chairman and CEO, Ron Williams; Mark Bertolini, President; and Joe Zubretsky, Executive Vice President and Chief Financial Officer. Following their prepared remarks, we will respond to your questions.

During this call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently-projected results are described in Aetna’s 2009 Form 10-K and our first quarter 2010 Form 10-Q when filed with the SEC.

Pursuant to SEC Regulation G, we have provided reconciliations of metrics related to the company’s performance that are non-GAAP measures in our first quarter 2010 financial supplement and our 2010 guidance summary. These reconciliations are available on the Investor Information portion of aetna.com. Also, as you know, Regulation FD limits our ability to respond to certain inquiries from investors and analysts in non-public forums, so we invite you to ask all questions of a material nature on this call.

With that, I will turn the call over to Ron Williams. Ron?

Ronald Williams

Good morning. Thank you, Kim, and thank you all for joining us today. This morning, we reported first quarter operating earnings per share of $0.98. Excluding favorable prior-period development, first quarter operating earnings per share were $0.77, $0.05 higher than the consensus estimate of $0.72, as a result of sound operating fundamentals.

Our commercial medical benefit ratio was 81.1% or 82.9% excluding favorable prior-period development, which is 60 basis points better than our guidance of approximately 83.5%. This first quarter performance was generally in line with expectations as a result of disciplined pricing actions and effective medical quality and cost management. First quarter results also include better-than-projected medical membership of approximately 18.7 million members, reflecting better-than-projected ASC growth. We are strategically positioning the company for future success, with the aspiration of shaping more effective healthcare systems. The three components of our strategy are: First, obtaining deep insight into the evolving needs of our customers to identify areas for future profitable growth; second, providing information and decision support to help our customers make better informed health decisions; and third, aspiring to achieve operational excellence in everything we do. We are pleased to report strategic successes in each of these three areas during the first quarter.

First, with respect to deep customer insight. Through sophisticated segmentation, we continue to diversify our revenue streams. Of note this quarter, we achieved commercial ASO membership growth of 157,000 members despite economic-related attrition of approximately 80,000 members. And by combining our strong geographical presence and marketplace relationships with acquired Medicaid capabilities, we were successful in growing our Medicaid business. In particular, we were awarded the new Medicaid contract in Pennsylvania, which combined with our new Medicaid Florida launch has the potential to add up to 60,000 new members this year, demonstrating our ability to provide value-added solutions to this growing marketplace.

Second, with respect to information and decision support, our transparency, integration and engagement initiatives are designed to improve quality and lower total costs for our customers. By leveraging the power of technology to provide personalized evidence-based information, our goal is to create an information-driven marketplace. For example, we recently launched realtime payment estimators that allow members to get the care they need at the price that's right for them. These estimators display the costs of various procedures in different settings based upon their specific benefit plan and current deductible status before the service is rendered. This realtime price transparency is the next step in our strategy to drive true consumer behavior by enabling value-based purchasing. Our success in this area is also illustrated by the results of a recent study of Aetna HealthFund consumer-directed plans which demonstrated substantial savings and better engagement for our customers. The study found that employers with full-replacement health reimbursement arrangement and health savings account plans saved $18 million per 10,000 members over five years. Our growing consumer-directed health plan membership reflects our success in selling and effectively administering these plans and now stands at 2.2 million members as of March 31.

Third, with respect to operational excellence. Aetna was recognized by Fortune as the most admired healthcare company for the third year in a row. In addition, our continued focus on operational excellence produced sequentially improved performance during the quarter across many of our operating metrics.

In turning to our 2010 full-year outlook, we now project a commercial medical benefit ratio of 83.5% to 84% and operating earnings per share of $2.75 to $2.85. This revised outlook includes our better-than-projected performance and favorable prior-period development reported in the first quarter. It also reflects updated membership and SG&A projections. Our revised SG&A projection includes our current estimate of the costs we expect to incur in 2010 to prepare for healthcare reform. Joe will provide additional details on our 2010 outlook in a moment. Mark will then provide an update regarding the key operational drivers of our projected 2010 performance.

First though, I would like to briefly comment on healthcare reform. There are still a great deal to be determined regarding how healthcare reform will actually be implemented. As anticipated, we are just now entering the regulation development phase and much in the legislation has been left to be determined by substantive regulation. We have been preparing for this phase for some time and are taking the same approach to the rulemaking process that we did to the legislative process. We are actively engaged in constructive, fact-based dialogue at the national level and with regulators in 50 states based upon our experience in making insurance markets work. Mark and Joe have mobilized a broad and experienced team to ensure reform is implemented at the company in a manner that is best for Aetna's customers, is compliant with all laws and regulations and continues to create value for shareholders. Once the regulations have been developed and there is more clarity with regard to implementation details, particularly those dealing with minimal medical benefit ratios, we will provide more specific guidance on our outlook. Although the recent legislation addresses access, the issues of affordability and quality remain unmet challenges for our nation.

Aetna plays a significant role in helping our customers, both employers and individuals, meet the total quality and cost challenge. We are looking across the healthcare landscape as we believe reform will create strategic growth opportunities with an even greater imperative to manage quality and costs. I have a great deal of confidence in Aetna and our long-term future. We are continuing to improve the operational performance of our businesses to ensure we reach our full potential.

We have a customer-focused strategy and a seasoned leadership team, and our financial strength and liquidity continue to be excellent. I would like to thank our employees for their dedication in meeting the needs of our customers. We are confident that through their efforts, we will be successful in 2010 and beyond. I will now turn the call over to Joe Zubretsk to provide insight into our first quarter financial performance and our 2010 outlook. Joe?

Joseph Zubretsky

Thanks, Ronnie, and good morning, everyone. Earlier today, we reported first quarter operating earnings per share of $0.98, an increase of 2% compared to the prior-year quarter. Excluding prior-period reserve development, operating earnings per share was $0.77. Operating earnings decreased 3% compared to the prior-year quarter to $431 million as lower Commercial Underwriting margin was offset by favorable prior-period development.

Other key highlights of the quarter include a Commercial medical benefit ratio of 81.1%, or 82.9% excluding favorable prior-period development, better-than-projected total medical membership of approximately 18.7 million members and excellent operating cash flows and very strong investment performance.

I will now discuss the drivers of our first quarter financial performance, starting with operating margin and its key components. First quarter before-tax operating margin was 8.7%, or 7% excluding prior-period development, which is 4.6% on an after-tax basis. First quarter revenue of $8.5 billion reflects a 1% year-over-year decrease in Health Care revenue. This was the result of a 1% decrease in Health Care premium and a 1% increase in Health Care fees and other revenue. Health Care premium reflects a net decrease in Commercial premium of approximately 3.5% resulting from a volume decline of 8%, an overall rate increase of 9% and a 4.5% decline from product mix. This mix effect is due to increased benefit buy-downs and the fact that the majority of our membership attrition was in higher premium products. This mix effect is a key driver behind the year-over-year change in our reported premium yields and medical cost trends. Health Care premium also reflects a 4% increase in Medicare premium and 11% growth in Medicaid. Growth in Health Care fees and other revenue of 1% is due to stable year-over-year volume and a 1% increase in yield, reflecting continued pressure on fee yields and lower product penetration in this challenging economy.

Our first quarter total medical benefit ratio was 82.5%, which includes $143 million before tax of favorable prior-period reserve development across all products: $92 million in Commercial, $38 million in Medicare and $13 million in Medicaid.

Our first quarter Commercial medical benefit ratio was 81.1%, or 82.9% excluding prior-period development, which is 60 basis points better than our guidance of approximately 83.5%. This favorable variance to guidance is due primarily to lower-than-projected flu costs. Our first quarter also included some slight favorability due to the severe winter weather. The commercial favorable prior-period development of $92 million is due primarily to lower-than-expected flu costs in the fourth quarter, lower-than-projected medical cost trend for the month of December 2009 and the partial release of a previously-disclosed provision for certain provider medical costs related to prior years. We are not projecting this lower 2009 medical cost baseline to result in a lower medical cost run rate for 2010.

Our first quarter Medicare and Medicaid medical benefit ratios were 87% and 85.9%, respectively. We continue to reflect appropriate assumptions regarding medical cost trend, operating metrics and payout patterns in setting reserves for estimated healthcare costs. Days claims payable were 46.9 days as of March 31, an increase of 3.1 days during the quarter due primarily to a temporary increase in pending claims that was fully reflected in our March 31 reserves. We project Days claims payable to be in the low 40s for the remainder of the year.

Group Insurance operating earnings were $29 million during the quarter, representing a year-over-year decrease of 32%. The majority of this decline was due to unfavorable Group Life claim experienced during the quarter, resulting from several large claims in one account, which unfortunately lost several employees in the Haiti earthquake, and higher than normal gains on long-term care reserve transfers in the first quarter of 2009 as we continue to execute our strategy to transfer much of this business to other carriers. Long-term disability performance was slightly ahead of our projections.

The third key component of operating margin results is operating expense management. We continue to invest in our future to capitalize on marketplace opportunities for future profitable growth. Our business segment operating expense ratio of 18.1% represents a year-over-year increase of 80 basis points and was in line with our projections.

We ended the quarter with 18.7 million medical members, a sequential decline of 226,000. This contraction reflects a decline of 416,000 Commercial insured members across many of our customer segments, an increase of 157,000 Commercial ASC members, which is net of estimated economic-related attrition of 80,000 and increases of 18,000 and 15,000 members in Medicare and Medicaid, respectively.

The final area of financial performance I will comment on is our investment performance and management of capital. First quarter investment performance was very strong. Net investment income on our continuing business portfolio was $186 million, $17 million higher than the prior year as growth in invested assets and stronger alternative investment returns more than offset a lower-yield environment. Our unrealized gain position on the continuing business portfolio improved and now stands at $598 million before tax as of March 31.

Turning now to liquidity and capital management. Our financial position, capital structure and liquidity all continue to be very strong. Our balance sheet metrics are excellent. As of March 31, we had a debt-to-total capitalization ratio of 29.3% and $7 billion of adjusted statutory surplus, $5.9 billion in excess of our reported regulatory requirements. We also continue to target a risk-based capital ratio of approximately 600% of the authorized control level.

Our liquidity is strong. We began and ended the quarter with holding company liquidity of approximately $100 million and $480 million of commercial paper outstanding. First quarter dividends to the parent were $330 million, which we deployed to fund $252 million of share repurchases and cover fixed charges of $78 million.

During the quarter, we repurchased 7.2 million shares. Our basic share count was 424.9 million at March 31, down from $430.8 million at the beginning of the year. HealthCare and Group Insurance gap operating cash flow for the quarter represented approximately 200% of operating earnings excluding pension expense due to the timing of tax payments and the temporary increase in pending claims mentioned previously, both of which are projected to reverse in the second quarter.

I will now provide some additional insight into our 2010 guidance. We now project 2010 operating earnings per share of $2.75 to $2.85, a $0.20 increase from our previous guidance. This projection reflects our current estimate for spending to prepare for healthcare reform, a weighted-average share count of approximately 430 million shares and the impact of the favorable first quarter prior-period reserve development as do all of our guidance metrics. In addition, consistent with previous projections, we project operating earnings per share in each of the remaining three quarters to be lower than the first quarter excluding development.

Medical membership is projected to contract by approximately 150,000 members during the remainder of the year with the majority of the change occurring during the second quarter, as additional contraction in Commercial insured and ASC membership is partially offset by growth in Medicaid. This membership outlook leads to a projected decrease in full-year total company revenue of approximately 3%.

With respect to medical benefit ratios, we project a full-year Commercial premium yield that exceeds medical cost trend, which we project to be at the low end of our 9%, plus or minus 50 basis point range. This leads to a 2010 Commercial medical benefit ratio of 83.5% to 84%, Commercial medical benefit ratios in the range of 84% to 85% for each of the remaining three quarters of the year and a 2010 Medicare medical benefit ratio that is higher than 2009 but still in the high 80s.

For the full year, we also project a business segment operating expense ratio of approximately 18.9%, an increase of 30 basis points, due to our lower revenue projection and additional investments, particularly operational and process changes related to healthcare reform implementation. We are also projecting a full-year before-tax operating margin of approximately 6.5% and a debt to capitalization ratio of approximately 30%.

In summary, we are pleased with our first quarter performance and are confident in our outlook for 2010. With that, I will turn the call over to Mark for commentary on our operations. Mark?

Mark Bertolini

Thank you, Joe, and good morning. I'd like to start with an update on our first quarter operating performance and then provide some insight into the initiatives we are taking to ensure continued success in an evolving regulatory environment. As a reminder, the actions we initiated last year to improve our operational performance fall into two main categories: Medical quality and cost management, and pricing and underwriting.

First, with respect to medical quality and cost management, we believe the quality and cost management actions we took last year are working as planned. These process enhancements focused on three areas: Claim payment and adjudication procedures; contractual changes for providers, ancillary contracts and fee schedules; and increased intensity of care and utilization management to improve quality and avoid unnecessary expense. As a result, our medical cost trend projection is now at the low end of our range of 9% plus or minus 50 basis points. This projection includes the effects associated with prolonged consumer and provider behavior changes and the impact of mental health parity legislation as well as inpatient costs trending at the high single to low double digits, outpatient costs trending at low double digits, physician costs at mid to high single digits and pharmacy costs at high single digits.

Next, with respect to pricing and underwriting. Given the challenging economic environment and our first quarter change in Commercial-insured membership, our achieved premium yields have been impacted by significant mix changes as expected. We believe our disciplined strategy to better align pricing with medical costs is working. The spread between our premium yield and medical cost trend improved sequentially by 420 basis points during the quarter from negative 570 basis points to negative 150 basis points, excluding the impact of favorable prior-period development. This spread reflects some of the continuing impact of some second and third quarter 2009 renewal cohorts, but was generally in line with our expectations. We project a positive yield trend spread for the remaining three quarters of the year. We are encouraged by our first quarter performance. We are focused on delivering an improved yield trend spread that will provide additional insight on our progress as we obtain further visibility into the impact of mix and potential seasonality patterns on our book of business.

I will now speak to the recent suspension by CMS of our marketing and enrollment for new Medicare members. We have built a very robust Medicare Part D business, now with over 600,000 members, and we take our obligations to our customers very seriously. Compliance problems of any nature are unacceptable to us. While we strive for service excellence with all of our customers, we did experience transition of care and other issues for some Medicare Part D members this quarter. We are working closely with CMS to address their concerns and fully resolve this matter as quickly as possible. This matter has my attention and that of Aetna’s entire senior team. Importantly, we have received a waiver from CMS to continue to enroll eligible members into existing contracted group Medicare plans through July 31, 2010.

Turning now to healthcare reform. Late last year, Joe and I mobilized an experienced team of leaders to ensure that reform is implemented in a manner that is best for Aetna's customers, is compliant with all laws and regulations and continues to create value for our shareholders. The team is focused on all aspects of healthcare reform legislation with primary emphasis on those areas having immediate impact, particularly mandated benefits and minimum benefit ratio requirements in 2011. In addition, Ron, Joe and I are engaged to ensure that we identify the strategic business opportunities that may emerge as the result of reform. We have strong working relationships with the parties responsible for developing healthcare reform regulations, and we look forward to a continued dialogue and sharing of ideas at both the federal and state levels to ensure a successful implementation of reform. We remain committed as we have been in the past to be part of the solution. With that, I will turn the call back over to Kim. Kim?

Kim Keck

Thank you, Mark. The Aetna management team is now ready for your questions. We ask that you limit yourself to one question and one follow-up so that as many individuals as possible have an opportunity to ask their questions. Operator, the first question, please.

Question-and-Answer Session

Operator

[Operator Instructions] And Josh Raskin with Barclays.

Joshua Raskin - Barclays Capital

Maybe you can elaborate on sort of the moving parts within guidance. It seems like there was about $0.20 favorable development and that seems to be what the EPS is building up, yet you did speak to better-than-expected core trends even excluding developments. So is there a way to size how much the healthcare reform costs there are and maybe some of the other drivers? You talked about improved spread and then I guess as sort of a follow-up to reform, could you just break down your Commercial membership by individual, small group, as you define it versus the MLR requirements within large groups?

Ronald Williams

Let me start out by saying that we felt like our first quarter was off to a good start. However, most of the favorable first quarter performance we viewed as one time in nature principally coming from the prior-period development and the flu. We think overall the first quarter was in line with our expectations and I'll ask Joe to give you a little more color on that and then I'll come back and talk a little bit about health reform generally.

Joseph Zubretsky

Josh, I think Ron had it pegged right. Most of the first quarter performance, while favorable, we view as non-recurring in nature, both the prior-period development and the favorable first quarter underlying results. So at this time, we see no need to reduce our medical cost forecast for the year. Obviously, as experience emergers, we might change our view. And I also think that your intuition about some of the other items was correct, but they generally offset each other. Our first quarter underlying Commercial list performance was favorable, but we have had to increase our SG&A forecast for the year, primarily to implement the operational protocols for healthcare reform. Those items largely offset each other so basically the prior-period development adds the increase to earnings per share for the year.

Charles Boorady - Citigroup Inc

And the breakdown of membership: individual, small group and large group?

Joseph Zubretsky

Our individual membership represents 2% of membership, and small group 6%.

Operator

And Scott Fidel with Deutsche Bank.

Scott Fidel - Deutsche Bank AG

First question just following up on some of the health reform impacts this year. Maybe without sizing the overall amount, could you maybe just talk about what the key buckets of expenses are when we think about things like early implementation of some of the insurance market changes, then some of the tax changes that we see, and for things like the elimination of the Part D subsidy and changes to executive deductibility of compensation? So just think about the different buckets, how are those influencing the reform costs this year?

Ronald Williams

Well, let me talk broadly, Scott, and I’ll ask Joe to speak to some of the components of it. I think generally, from the organization's point of view, we're maintaining the same level of intensity and focus on the implementation of the legislation that we did during the development of the legislation. So that means that we're working very aggressively at the national level in terms of our lobbying activity and thinking meaningfully about the potential regulations, the systems changes, the changes in different parts of the value chain that we work with. I think generally, it's still very early, so our approach is to be very well-prepared for this. And I'll ask Joe to give you a little bit breakdown on how some of the investment elements relate to that.

Joseph Zubretsky

Scott, just to respond to three points you raised, first on the mandated benefits. We’ve assumed in our forecast and our projection that we would be able to price for them. Now, if we’re not able to get all the premium, that would put pressure on our EPS outlook. With respect to the costs, one of the reasons the SG&A outlook for the year has been increased is we want to get it right and it’s a necessary spend, we want to make sure we have all the operational protocols in place, and that's the main driver behind our SG&A increase for the year.

With respect to deferred compensation or executive compensation, we did not have a deferred-tax asset up for that provision and, therefore, no write-off.

Scott Fidel - Deutsche Bank AG

And then I just have one follow-up question and know it’s obviously very early here relative to the exchanges, which don't go up for a number of years, but just interested in your initial thoughts on the structure of those and whether you think the exchanges could be a viable business and how should we think about that business relative to is it more going to look like what we think about sort of certain government businesses like Medicaid or do you think this could be more like a commercial-margin type business?

Mark Bertolini

Scott, Mark Bertolini. A couple of ways to think about it. Obviously, we have a long way to go before we get regulations and rules in place, but one extreme would be the kind of exchange we have in place with the Connector in Massachusetts, fairly highly regulated, very prescriptive, not a whole lot of opportunity. Then on the far end, you could have more of an eBay kind of structure where you have a more open market where you can bring together a lot of buyers and sellers, and all the things in between, like the FEHB program. So I would expect that as we go from state to state and in my conversations with insurance commissioners across the country, they’re all over the map about how they think about exchanges within their markets and so a lot of conversation to go yet, but we can see the full range depending on how the regulations emerge.

Operator

And John Rex with JP Morgan.

John Rex - JP Morgan Chase & Co

Just focus back on reform also and the minimum MBRs for ‘11. Can you tell me, so say if we don't know the rules really on the minimum MBRs until July or August, what percent of your Commercial member month, and in particular I guess I'm focusing on the Commercial member month in the individual and small group books, would be committed to already, so in terms of the roll into '11 for business you're signing today and over the next couple of months. And then I guess the second point is are you able to build in any flexibility into the distribution agreements now for kind of the unknown of how these MBRs might be implemented?

Ronald Williams

John, when you think about the renewal cycle, particularly for the individual and small group, those typically renew much more on a sequential basis, meaning that there isn't a long lead time. So, for example, we'd be renewing January for small group essentially in November, October-November period. And for individual it would be very similar. So there's still plenty of lead time for us to understand what the regulations would be, to be certain we’re compliant and most importantly to be certain that we understand how the business model has to evolve to make certain that we're meeting all of our obligations.

Joseph Zubretsky

And then, John, on the distribution front, we’ve had rolling conversations with our broker advisory councils for more than two years on this very topic, the impact of minimum MBR, on their ability to put their costs through the premium. And obviously there are many different ways we can address this as we go forward and, again, it depends on what the definition of minimum MBR includes. We have an ongoing dialogue, we're working with them. I think it's time for everybody in the system, not only brokers and insurance companies but also providers, to begin to prove their value and I think we’re going to see that happen in the distribution model as well.

John Rex - JP Morgan Chase & Co

And can you just size what you think about say by August 10, what percent of an individual and small group member months would be committed to -- with regard to be signed, so that extended to July or August renewals that roll into the next year, would that be like 30%, would it be 40% of the full-year ‘11 member months?

Mark Bertolini

We wouldn’t be able to give you that number, John. But what I would tell you is, is that nothing’s cast in concrete. When we put our pricing in the marketplace, we have the ability to make changes where we need to make them. So I wouldn't assume that whatever gets priced in the first half of the year is immutable.

John Rex - JP Morgan Chase & Co

And then just on the distribution agreement, is there explicit flexibility to change commission structures or is that something that really happens once you know the rules?

Joseph Zubretsky

I wouldn't want to comment on that at this time.

Operator

And Christine Arnold with Cowen.

Christine Arnold - Cowen and Company, LLC

You mentioned contractual changes with providers. Could you speak to that? And also you talked to the SG&A costs associated with reform about 30 basis points. Could you speak to the medical trend assumptions that you have related to healthcare reform? Because you said you assume you can price for them. I’m just curious what you think the number is.

Ronald Williams

In terms of the providers in general, I think that when we look at healthcare reform, I think we all understand that the bill focuses very much on getting access addressed and improved for those individuals who didn’t have coverage. That the pieces of the system that need to be fixed, which continue to be quality and affordability, weren't in scope of the legislation but still remain to be critical issues that we as an industry are going to have to make certain we’re focused on. So we're spending our time working collaboratively with providers with a very strong focus on how we increase affordability and how we make certain that we do so in a way that addresses quality. So we have lots of different programs underway, about 18 different arrangements that range from medical home to different types of payment for quality incentives, that all represent what we view as kind of the next generation of collaboration.

Joseph Zubretsky

Christine, with respect to the ability to price for the additional benefits for the rest of the year, we've contemplated that in our guidance. If there's risk to that, think of it as being in the range, which is one of the reasons we provide a range. So we're comfortable that we can price for it.

Christine Arnold - Cowen and Company, LLC

Can you quantify it?

Ronald Williams

We are not quantifying the impact specifically as to the risk to the range.

Operator

And Carl McDonald with Oppenheimer.

Carl McDonald - Oppenheimer & Co. Inc.

The corporate strategy has been one of a multi-year repricing cycle to try to bring margins back to where they had been historically. Do we need to rethink that strategy now in light of some of the reform changes and particularly some of the limitations that may be there from a margin perspective?

Ronald Williams

I would say, Carl, that our strategy remains the same, but obviously is informed by new facts and new data that we receive. And so we are watching carefully to see what unfolds in the near term with the regulatory changes, but I think it’s clear from our point of view that we think we have the right strategy long-term.

Operator

And Anna Gupte with Sanford Bernstein.

Ana Gupte - Sanford C. Bernstein & Co., Inc.

Just a follow-up on the CMS marketing suspension. Is this restricted to individual only, or is it also going to impact your open enrollment for group employer-sponsored business in the fall and then just detail on that? From our numbers I think in MedPAC, about a quarter of the 45 million seniors right now get employer-sponsored retiree benefits. What percentage of that addressable market do you see can be captured and how would you respond to the Sigma Humana Alliance?

Ronald Williams

Anna, let me address first the sanction. The sanction, obviously, is something that we are not very pleased with and are working very quickly to get resolved before open enrollment next year, so that is our aim in working with CMS. And so we have a team on that and very high level of visibility in the organization on a weekly basis around the activities to get the sanction lifted. The group labor that we have is directly related to allowing agents to enroll into the program for groups you already in place. We can continue to consult with groups but we cannot engage in any marketing to groups at this point in time, so the marketing sanction is for both groups and for individuals. But we can continue to work with groups to consider their options around healthcare reform. Obviously, it all depends on us getting opened up for open-enrollment period, which begins November 15, is our objective. I would not want to comment on another competitor’s actions on the marketplace as particularly Medicare is a fairly robust and competitive one, and we believe we have a competitive offering.

Ana Gupte - Sanford C. Bernstein & Co., Inc.

And with regards to the captive PBM, does this or in general does it change your view or catalyze your view on the PBM divestiture?

Ronald Williams

Our stated strategy is really the same, that we believe that integrated-value proposition and how we use the data and information and have clinical impact continues to be an important part of what we do, and we're always looking at opportunities to improve the value that we offer customers.

Mark Bertolini

And, Anna, we believe that the integrated-value proposition is proving to be strong as we deal with the mental health parity regulations that are going in place today where we’re able to pull together all the benefits both in mental health parity and in the medical benefit for our customers.

Ana Gupte - Sanford C. Bernstein & Co., Inc.

Just as a final follow-up on that, would there be a way for you to structure an agreement or a transaction where you can maintain the integrated model and still potentially capture more value from the way your PBM moves?

Ronald Williams

I think I would say simply that our strategy remains the same.

Operator

And Justin Lake with UBS.

Justin Lake - UBS Investment Bank

First question, just looking at the results, the ASO fees and yields look pretty strong in the quarter versus what we were expecting. Can you talk about that segment and how it looks versus your internal expectations and any update on how the economic environment is impacting the business?

Ronald Williams

Well, Justin, we did guide that we would see continued pressure on buy-ups in ancillary products. We believe we will for the remainder of the year although we did have a very, very good quarter in what I'll call the ancillary product lines and national accounts but are not forecasting that to recur in the last three quarters of the year.

Justin Lake - UBS Investment Bank

So was that everything you expected?

Ronald Williams

For the first quarter, yes.

Joseph Zubretsky

And, Justin, the market does remain competitive, however, and we see a lot of activity in the market around the national accounts and large self-funded employers. We see some shift into self-funding with those customers, but all in, the market remains a very competitive market.

Justin Lake - UBS Investment Bank

And then second question, looks like you lowered your membership numbers a little bit for the second quarter. I’m just wondering what the driver is there, and can you talk to your experience in new sales activity or retention while you were going through your repricing here?

Joseph Zubretsky

Our repricing yielded the kind of results we expected to see in our risk membership in the first quarter. And our levers and stairs analysis shows that the levers generally how higher MBRs than the stairs do. So we feel comfortable that our pricing model has worked. As we go into the second quarter of the year, though, we’re seeing some continued deterioration in the Commercial risk market, which we would expect to happen, and that will be offset by some Medicaid enrollment.

Justin Lake - UBS Investment Bank

Is that an economic-driven deterioration or is that [indecipherable]?

Joseph Zubretsky

The economic attrition actually is better than it was last year and shows signs of improvement at this point in time.

Justin Lake - UBS Investment Bank

And what's going on with the second quarter then?

Joseph Zubretsky

It's the pricing models. We continue to have the cohorts from the second and third quarters from last year that needed to be priced up still are in the market at a higher price than just trend.

Operator

And Sarah James with Wedbush Securities.

Unidentified Analyst

I'm trying to get a better understanding of the timeline for the commercial MLR regulations and a few of the milestones along the way. So I was wondering if you could comment from whether your conversations at the federal level, if the June timeline still seems achievable, if you think this will be a final or developing definition, how long it may take after that to get some clarity at the state level and, lastly, once you get the final regulations, what a reasonable timeline might be to evaluate and provide comments on the impact.

Ronald Williams

Well, I think in general, I think this is a [blank space on audio tape] with the twin issues of making certain they’re doing the right job of affordability for the consumer while making certain that there is solid financial solvency in the insurance industry to be certain that plans will be there to pay the claims when they come due. From a timeline perspective, we're sharing our point of view with both HHS and NAIC. And NAIC will be actively engaged in comments, and we'll publish their definitions in June, which will then be the basis for the Secretary to make some additional judgments and really publish regulations that we would see taking effect essentially in late September, early October. I think that as they have begun to dig into this, I think there is a lot of very serious thought and an understanding of the complexity of the issues involved and really balancing these twin issues of both affordability as well as maintaining long-term solvency in the system.

Unidentified Analyst

Okay, but September or October you would expect to have the details that you would need to evaluate the changes?

Ronald Williams

Yes, I think that given the time that they have, my suspicion is that there would be something called interim final regulations which would be a process that HSS can use. And then, like all regulations, I suspect they will be in place for a while, they’ll take a look at them and figure out what changes, if any, seem to be appropriate, but those are judgments they would have to make.

Operator

And we'll take our last question from Kevin Fischbeck with Bank of America Merrill Lynch.

Unidentified Analyst

Can you talk a little bit about the seasonality in MBR through the year? I guess even if you back out the development in Q1, most companies talked about internal MBR increasing it during the year as deductibles wear off, but you seem to have a pretty big step up in Q2 MLR and then somewhat stable through Q2 to Q4. Could you talk a little bit more about that?

Ronald Williams

Kevin, you really have to follow the eight quarters for 2009 and 2010 to understand the picture. Keep in mind we had a very, very difficult comp in Q1 of 2009 where we posted an 81.7% medical benefit ratio, then experienced the influxion of medical costs for the balance of the year. So if you look at our forecast for the balance of 2010, it shows a positive spread between yield and trend and a lower MBR than we experienced in the last three quarters of 2009. So you really have to look at the membership flows and where we hit the influxion point on medical costs to understand the seasonality, but we’re very comfortable that this is the right seasonal approach to forecasting the MBR.

Unidentified Analyst

So I guess the normal seasonality the rest of the year might be a little bit dull given the fact that you're getting a repricing benefit when maybe other companies are not?

Ronald Williams

I agree with your assessment. It's very difficult to understand the underlying seasonality when you look at the financial statement results for the past two years, but we think we have this pegged right.

Joshua Raskin - Barclays Capital

And then you made some pretty bullish comments on the Medicaid space in your prepared remarks. With healthcare reform passed, how has your view on that space changed, if at all? And does it make more sense to get more aggressive in RFPs or acquisitions to get into new states before that enrollment starts to grow significantly in 2014?

Ronald Williams

I think from a general perspective, we're very pleased with our Medicaid strategy. I think the acquisition that we did a few years ago has worked the way that we had hoped it would, meaning that we have taken what was a very good asset, had really good scale, coupled it with our presence in a variety of geographies, the strong reputation we’ve built in working with regulators and others in the small group and sometimes individual markets. And what we're finding is that in combination to that, we're winning new contracts. And I think the examples, Pennsylvania, the launch we've had in Florida. We've had other wins. So strategically we’re very comfortable with where we are and feel that the growth we’re getting that's organic is good. And I'll ask Mark to maybe talk a little bit more about that.

Mark Bertolini

So, Kevin, the way we think of the priorities right now in Medicaid, given the current budget issues that states are facing even though they have FMAP funding, there is this potential that FMAP funding goes away, so the states are very cautious about their current rates. And so we have those discussions going on across the country, very open dialogue, good exchange. So we see organic growth as the first opportunity. So the RFPs that you mentioned are important. Pennsylvania, we picked up risk-based TANF in ADB populations and in Florida it’s TANF and SCHIP fee-based. So we see, first, ASO kind of arrangements as a preference and then into risk-based, particularly around ADB.

Kim Keck

A transcript of the prepared portion of this call will be posted shortly on the Investor Information section of www.aetna.com. If you have any questions about matters discussed this morning, please feel free to call me or one of my colleagues in the Investor Relations office. Thank you again for joining us this morning.

Operator

And that does conclude our conference for today. Thank you for your participation.

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