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Universal American Corporation (NYSE:UAM)

Q4 2013 Earnings Conference Call

March 6, 2014 8:30 AM ET

Executives

Richard A. Barasch – Chairman and Chief Executive Officer

Anthony L. Wolk – Senior Vice President, General Counsel and Secretary

Robert A. Waegelein – President and Chief Financial Officer

Analysts

Matthew R. Borsch – Goldman Sachs & Co.

Kevin Fishbeck – Bank of America Merrill Lynch

Anna Gupte – Leerink Partners

Carl McDonald – Citigroup Global Markets

Scott Fidel – Deutsche Bank

Tom A. Carroll – Stifel, Nicolaus & Co., Inc.

Operator

Greetings and welcome to the Universal American Corp. Fourth Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Richard Barasch, Chairman and Chief Executive Officer. Thank you. You may begin.

Richard A. Barasch

Thank you, and good morning, everyone. Thanks for joining us on our fourth quarter 2013 conference call. I’m here with our CFO and President, Bob Waegelein; and our General Counsel, Tony Wolk.

Now, I’d like to ask Tony to read our Safe Harbor language.

Anthony L. Wolk

Thanks, Richard. Before we begin, I would like to remind you that we have posted a presentation for this call in the Investors section of our website at www.universalamerican.com. I would also like to remind all participants that our call this morning may contain forward-looking statements within the meaning of the federal securities laws.

These statements, which reflect management’s current expectations, projections and beliefs are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of these risks and uncertainties, we recommend that you review the company’s risk factors and other disclosures set forth in our SEC filings.

We undertake no obligation to update or revise any forward-looking statements to reflect events, developments or circumstances after the date hereof. During the call, we will also be referring to certain non-GAAP financial measures. Please refer to the reconciliation tables listed in the press release for a discussion of these non-GAAP financial measures. Richard?

Richard A. Barasch

Thanks, Tony. Good morning. I’m going to dispense with my usual discussion of the regulatory and political environment. I would like to note, however, the deep bipartisan support for Medicare Advantage as evidenced by the Congressional letters that were issued before the 45-day letter came out, and the support from both sides of the aisle, from mitigation of some of the more deleterious aspects of the proposed rule.

It’s not long ago that we wondered about the future of MA now at 30% of Medicare beneficiaries and support from both democrats and publicans, we know it’s here to stay. There is no way to sugarcoat our results. We had a crummy year from a financial perspective and our APS Healthcare acquisition has been extremely disappointing as highlighted by the full write-down this quarter of the remaining goodwill.

Nevertheless, we also had some significant advances in 2013, most notably our improvement in Star ratings that puts us in a great position to regroup and enter the next phase of healthcare reform and our company’s cycle with a great deal of optimism.

Universal American as a solid capital base, a core of solid and promising business assets, and a business plan that is designed to participate profitably in the rapidly changing healthcare environment. Our Bob Waegelein will begin by discussing our financial results. Bob?

Robert A. Waegelein

Thank you, Richard. I’d like to remind you that we posted additional information regarding our operating results in the financial supplement that can be found on our website in the Financial Reports tab of our Investors section.

Let’s turn to Slide 4. As you can see for the fourth quarter, we reported an after-tax loss of $101.8 million, or $1.16 per share, which includes $87.5 million of non-cash asset impairment relating to our APS acquisition, $8.6 million of after-tax expenses as we’ve continued to invest in our ACO business, and approximately $2 million of tax reserves against certain tax items relating to APS.

Excluding these items, we posted an adjusted after-tax loss from our operations of $4.1 million, or $0.05 per share. Our Medicare Advantage MBR for the fourth quarter was 80.8% compared to 84.6% in the third quarter and our adjusted loss ratio for the quarter was 83.1% compared to 86.3% in the third quarter.

The administrative expense ratio for MA business in the fourth quarter was 17.4%, seasonally high due to the sales and marketing expenses incurred during the AEP and member outreach programs typically done in the fourth quarter.

The traditional business reported a small loss in the quarter as a result of posting some additional non-cash reserves on our long duration products of approximately $3 million.

Let’s turn to Slide 5, to review the Medicare Advantage performance for the year. As you can see, the MA business operated profitably in 2013, earning $53.5 million and $1.6 billion of premium with a reported loss ratio of 83.4%.

However, looking at Slide 6, you will note the disparity between our core and non-core MA businesses, including the global markets. After eliminating the out of period items, the core markets MBR for the quarter was 83.4% and for the year was 83.3%. This MBR was within our expectations and fairly consistent through the year in our HMOs and most notably improvement coming from the Northeast markets after an unusually high second quarter and beyond.

Not surprisingly the weakest results were in our non-core network and rural private fee-for-service businesses. For the year, the adjusted MBRs for these products were 85.8% in non-core network and 90.9% in rural private fee-for-service much higher than we anticipated on our 2013 bids. To mitigate this issue, we are not offering a rural private fee-for-service product in most of the country in 2014. We had around 11,000 members in those plans.

Returning to Slide 5, we recognize that the run rate level of administrative expenses in our Medicare Advantage business is too high, particularly as we reduced our footprint in the non-core markets. We are committed to take the necessary actions to bring the cost structure in line with our membership size. It’s important to note that included in the 14.5% administrative expense ratio, our quality initiative expenses that will be reported in the medical benefit expense line for 2014. This complies with the presentation around us in the ACA. For 2013, these expenses represented 1.8% of premium.

The traditional business continues to perform well in its runoff, earning $10.9 million on premiums of $233 million for the year. Our corporate segment includes the operating results of APS that generated a loss of approximately $8 million in 2013, and includes the expenses incurred by our corporate functions, including debt service.

Our investment activities performed well generating $9 million in after-tax gains. We continue to incur expenses related to our ACO business, in 2013, we spent $41.5 million, or $26.7 million after-tax. Since we have not received any information from CMS regarding the level of any savings achieved in our ACOs, we cannot recognize any revenue for the fourth quarter.

Rather any savings generated for the period April 1, 2012, through December 31, 2013 will likely be reported as revenue in the third quarter of 2014. Finally, for the year, we recognized non-cash asset impairment charges relating to our APS acquisition totaling $178 million after-tax.

Moving to Page 7, we’ll look at the balance sheet. As of December, we have $2.1 billion in total assets, including $96 million in unregulated cash at the parent that’s the after paying $140 million of dividends in August. Our book value at the end of the year was $7.48 per share and when we exclude all our intangibles, the deferred acquisition costs, goodwill, and other intangible assets, we ended the quarter with a tangible book value per share of $5.72. And our total capitalization ratio was 17.9%. Richard?

Richard A. Barasch

Okay, excuse me. I’d like to start by amplifying some of the comments Bob made about our MA results. Clearly, the results of the year and certain portions of our MA business didn’t meet our expectations, but I’d like to add some perspective to these numbers.

When we reported our second quarter MA results, we were very concerned that our MBRs were spiking higher than we had anticipated. As you can see from the full year results, our MBRs especially in our core markets have come down. As Bob noted, we saw an uptick in utilization in 2013 in certain parts of our business, but turn back to Page 6, and when you dig a little bit further into the results they tell a story that’s consistent with the way we’ve been thinking about the evolution of our business over the next few years.

First and most important, our HMOs in Texas and Oklahoma continue to perform well. Loss ratios came in at 82.6, a bit higher than we expected and higher than last year, but on the glide path to be 85% requirement for 2014.

As I have often stated, Medicare Advantage will hold up well, only where we can impact the cost of care and improve quality. And our HMOs, that is largely accomplished through our partnership with primary care providers, a model that has been and will continue be vibrant through the reduction of the benchmark rates enacted by the ACA.

In Houston and Beaumont, we enjoy a market leading position that is powered by a longstanding and successful relationship with primary care providers and should be further solidified our membership growth in 2014 and the positive effective increase in our Star ratings in the 2015 bid.

As to the 45-day letter while it could have been worse. We still face headwinds that unless modified in the final rule. We will have to overcome with further operational and medical management improvements. There will likely be additional markets that will not – that will not be sustainable for us to remain in as participants.

Along with this Southwest HMOs, we have identified core markets especially in the Northeast, in particular upstate New York, where we have a history with providers due to our concentration of membership and long history in the market going back to our meds updates.

As noted, we did see higher utilization in the Northeast markets in the first half of the year, but our MBRs in the second half of the year improved substantially, bringing them approximately to where we had originally expected. A key to our ongoing success in these markets will be our ability to work more closely with the providers to improve health outcomes and lower costs.

The improvement in our Star ratings in the Northeast is not only a market improved quality, but also a market greater cooperation with physicians in these markets. We now have a complementary collection of assets centered around upstate New York, where we serve nearly 30,000 Medicare Advantage members, 13,000 Medicare fee-for-service beneficiaries through our ACOs, and 35,000 Medicaid lives through our Total Care acquisition, which closed in December of 2013.

In addition, we chose central New York to experiment with the health benefit exchange product. We do not expect material membership in the first year, but we will gain valuable experience. We're very content to go slowly here. As Bob said, it’s not surprising there are worse results came in the non-core segments, where the membership is diffused geographically, which weakens our ability to influence the behavior of providers and members.

Based on these results, we feel confident in the actuarial basis of our 2014 bid, assuming we continue to improve our medical management outcomes in our non-HMO businesses. Our benefit ratios remain favorable in the plans, where we have a high degree of provider engagements and member satisfaction. While we’re in the early stages of ramping up our efforts to bring more effective care coordination to the Northeast, we believe that with time, our effort should favorably impact these results.

For the past couple of years, our strategy has been to focus our marketing resources on building membership in our core markets as the non-core membership shrinks. As you can see, we stopped doing rural private fee-for-service outside New York in 2014, which will eliminate the worse drag on our overall MBR results.

You can see from the distribution of our membership on Slide 9, I could see that we had a very, very good 2014 AEP especially in our Southeast Texas market, where we experienced 13% growth. A particular note this enrollment rate was less than 3%, which means that our members are very pleased with the offering of healthcare that we provide to them through our partnership with primary care physicians.

Finally, and most important, we must accelerate our efforts to bring our administrative expenses down. If you just look at the MBRs for the company as a whole and especially in our core markets, they are for the most part on target, especially as we head towards minimum MBRs. But we still haven’t reached our ALR goals. This is a major focus for us and we expect to see meaningful improvements in 2014 and 2015. Accomplishing the needed decrease in ALR, while we are not growing and perhaps even shrinking membership is even harder, but we know we’ve got to do this.

Jumping over to Slide 8, we’re now in the process of building our 2015 bids, and we can see the tangible benefits of the substantial corporate wide effort to increase our Star ratings for 2014. And the effort and expense to improve the quality of our plans to the benefit of our members have clearly paid off.

Approximately, 75% of our core members are now in plans that have achieved a four star rating, most notably our two biggest plans in Texas and the Northeast. Not only do we make absolute gains, which will have a significant revenue implication for us in 2015. We’ve made relative gains measured against key competitors in our core markets.

I’d like to clarify, however, a point that I’ve been making. We assume that the four star ratings would give us a full 5% bonus. However, there are some offsets in the 45-day letter and the law that get us to around 70% of the 5%. Unless there were changes made in the final rule, we will phase into the full bonus over the next two years, assuming we maintain a four star rating. Nevertheless, now that the 2015 bidding season is upon us, we are able to plan for our future in MA, with reduced headwinds and increased optimism.

Turning to Slide 7, I would like to discuss our ACO business. When the Medicare Shared Savings Program emerged from the 2010 health reform bill, we anticipated that the sort of techniques that have been used in our successful and enduring partnerships with primary care physicians in Texas HMOs would also work in the fee-for-service population.

Our ACO business is a logical expansion. We aligned the stakeholder financial incentives around cost and quality and then provide data, technology, care coordination, to physicians primarily PCP, which enhances their ability to identify and close gaps in care, improve quality and ultimately get patients compliant and healthy, so they stay healthy and avoid preventable high-cost acute events.

We are actively engaging with our ACO partners to deploy the care coordination techniques to close these gaps and reduce overall costs. We’re also providing actionable data and analytics to the physicians that enable them to better manage the care of their patients.

In addition, we are highly focused on working on creative approaches to enhance our engagement with beneficiaries, so they take a more active role in the overall quality and cost of their healthcare. It’s important to reach out to these individuals as well as to allow the primary care physicians to stay informed.

While the program is still in its early stages, we believe we are building a distinctive and important business for Universal American and we will seek to leverage the capabilities and relationships that we are building into new areas. It’s also very important to note that CMS has recently issued in RFI the requester information, regarding the possibility of turning ACOs into full risk-bearing entities, if implemented, this could present a very interesting extension of our ACO efforts.

This hasn’t been an easy period for Universal American. But we are working off a solid capital base and have the well expertise and capacity to participate profitably in the highest growth parts of the healthcare system.

A few comments on capital, even after the $1.60 dividend paid in August and a large write-down in goodwill, Universal American continues to be well capitalized. At the close of the fourth quarter, we still had over $200 million of excess capital and 350 RBC and total book value of 748 per share, including $572 of tangible book value supporting our business.

It’s worth noting including this latest dividend, we distributed $18.60 per share to our shareholders since August of 2010, and we still have lots of financial flexibility going forward to invest in the area that we think have high growth potential. These actions are consistent with our longstanding commitment to use our capital well and returned capital to our shareholders that we are not fully employing in our business.

Now, let me spend a moment discussing APS. Required APS with the expectation that the acquisition would accelerate our entry into the Medicaid market particularly around do eligibles, as well as providing additional medical management capability for our own MA and ACO businesses. Clearly, this has not happened as planned.

In the year prior to the acquisition, APS generated approximately $30 million of EBITDA, but APS’s earnings have decreased significantly since then, including a loss of approximately $10 million in 2013. This deterioration in actual earnings and lower projections of future earnings led to the non-cash pre-tax impairment charge of approximately $91 million in the second quarter and $98 million in the fourth quarter. The primary reasons for the reduction in earnings are the shortfalls in the scope and profitability of the existing APS business that we acquired and the failure to win new contracts as projected.

Despite these disappointing financial results, we remain committed to providing the highest level of service to our existing state and health plan clients. In addition, Puerto Rico is in the process of an RFP process in which the managed behavioral program that APS has been performing will now be carved into the overall Medicaid benefit. We are working closely with potential bidders who may need our services.

As we have disclosed, we believe that we have significant legal claims stemming from the APS acquisition and are pursuing those claims vigorously. I appreciate that you may want more specifics about the lawsuit, but I’m sure you can understand why we won’t be able to go into any more details.

The Universal American has a successful history of demonstrating how the private sector can participate constructively in this type of evolving and growing market. In the new and rapidly changing world of healthcare delivery, we have positioned Universal American to thrive in large part due to our ability to partner with providers largely primary care physicians to achieve these goals.

Thank you for your time this morning. Bob and I will be happy to answer any of your questions.

Question-and-Answer Session

Operator

Thank you. At this time we will be conducting a question-and-answer session. (Operator Instructions) Our first question today is coming from Matthew Borsch of Goldman Sachs. Please proceed with your question.

Matthew R. Borsch – Goldman Sachs & Co.

Yes, realizing this isn’t the most urgent thing, let me just ask first about the ACO full risk-bearing proposal, and what you think that would – what you think that would do and how you would expect to maybe exploit that?

Richard A. Barasch

Well, it’s still in – let's you kind of bring it into context. It’s early and it won’t be for a couple of years, but I think it’s a – my person of view and now I am getting with the company is that we are headed to define contribution in Medicare. I think that – via reference to with the earliest part of the conversation is a very deep bipartisan support from Medicare advantage.

And underlying that is a support for ultimately getting more people on the Medicare advantage, which is more of defined contribution sort of a program. The ACOs allows this to happen in a different way on top of the fee-for-service chaise. So really what I think these is – is RFI designed to do is to see if there is a way to use, there are almost 6 million people in the ACOs right now, 6 million Medicare beneficiaries. So the notion of bringing those people into more of a program where providers are sharing in the risk with the government, it is clearly a very important part of policy makers thinking frankly on both sides of the aisle.

This is good for sort of the more progressive folks you don’t want to give up the entitlement, so it’s built on more fee-for-services and more freedom of choice and it’s also appealing to the folks who want to get more managed care and more defined contribution.

So we are sort of playing this. We’ve been at, we answered the RFI. We think that there is going to be support in the government, we think that this kind of have a bipartisan appeal, so it’s our – right now it’s our hope maybe more as an hope, because I think there is some action on this. But it’s our intention is to bring as many of these 30 odd ACOs into a position to be with their entities in the near future.

Matthew R. Borsch – Goldman Sachs & Co.

And if I could steer over to the Medicare rate outlook for -- the MA rate outlook for 2015, can you tell us how important is the home visit assessment from your standpoint to risk scoring on your clinical care model? And if you can put any numbers around that, that would be great. And just related to that, a large competitor of yours has talked about the all-in rate impact, excluding that, being in the range they see of 3.5% to 4% negative. Do you have an estimate that you could share with us?

Robert A. Waegelein

Yes, we’ve been reluctant to give the estimates; we’re doing the work, right. It’s a very H number plan county specific. So you can – the average may not tell you exactly what you want to know. But our large competitor is a very smart company and using them as a guideline will never steer you wrong.

As to the home visits, again, it’s not a – first of all it’s not a zero to certain number, it’s not going to be zero. There are many, many other ways to have people appropriately and I say they were appropriately coded for revenue purposes. So I think that –I don’t think it’s – I think some of the higher numbers that I've seen floating around are kind of unrealistic.

I think that, yes, clearly we’ll have an impact, we’ve done home visits. It’s a home visit program goes away, it’s going to put pressure on us, no issue about that. But the pressure is going to be to try to get the appropriate coding done in a different way not to give up on getting the appropriate coding.

Matthew R. Borsch – Goldman Sachs & Co.

Got it. And just one last, can you talk about what you saw in utilization trend in the fourth quarter and any preliminary early read on what you’re seeing so far in the first quarter?

Richard A. Barasch

Yes, too early for the first quarter, so I’m going to make that easy. In the fourth quarter we saw little flu. We saw little – you get a few extra events in a book as large as ours in Houston and they move the numbers around, where we do our reserving very particularly, very granularly on a monthly even basis, quarterly basis, we saw very good rebound in most of our markets. And the HMO is sort of maybe a pick up but nothing that's alarming. I think you used the word, they are in this one line.

Matthew R. Borsch – Goldman Sachs & Co.

Yes, okay. Fantastic, thank you.

Operator

Thank you. Our next question is coming from Sarah James of Wedbush Securities. Please proceed with your question.

Unidentified Analyst

Yes, hi. This is Nathan filling in for Sarah. I was wondering if you could describe your plan for right-sizing overhead costs, and if there was a target percentage or dollar amount that you're trying to achieve? Regarding this plan, how much of this will come from staff reductions, and is there any consideration to outsource some back office functions?

Richard A. Barasch

It’s a great question and you’ve answered a good part of it in your question. We’re going to use all the techniques. At the end of the day, I would say, I was very pleased when the same large competitor has been using this formulation for a while, which is 85/10/5 formulation and our target is 10, where a couple of hundred basis points ahead of that little bit more than that when you back off the medical management quality initiatives that move to the ALR section.

But we’re going to – part of it is just good force we had a wonderful new head of operations Mr. Steve Black who has done this before another places, we’re looking at other forms of outsourcing, we’ve the flip slide of this and I just this is the really hard part. Is that we have made such strides on quality in this company over the past three years or four years, that we just, we’re always mindful of, not getting to a point on costs, that you really put quality and compliance in jeopardy..

So there's a balance here. We have to maintain our vigilance on those issues as well. So all the techniques, some of it is brute force, some of it is brute force, some of its efficiencies, frankly the fact is our operations in more efficient, and you know one of the great things about the star rating it even recognized some more operational efficiency like cost centers, time for efficiency enrollment and things like that, as we’ve gotten better I think those will naturally help our numbers improve, but we’re if we looking at issue, we’re looking at ways to improve our software, it's a full coin press.

Unidentified Analyst

Okay. Great. And if I may, I would also like to touch on how the corporate segment included EPS? Can you break out the impact of EPS in the quarter, and how should we think about this trending into 2014?

Robert A. Waegelein

Again for the year we had a $8 million operating loss in reflected in the quarter that was about $3 million or $4 million at rather for the year, $3 million or so for the quarter, we don’t really give our forecast that in with guidance, but we have right side the lot of the operations in APS to reduce some other strength.

Richard A. Barasch

And I think, and one thing that I can guarantee you in 2014 is there won’t be any more goodwill write downs..

Unidentified Analyst

Great. Thank you very much.

Operator

Thank you. Our next question is coming from Kevin Fishbeck of Bank of America. Please proceed with your question.

Kevin Fishbeck – Bank of America Merrill Lynch

Great. Thanks. So just wanted to confirm, so you're saying that the G&A number that you're going to report next year is going to have that 180 basis point switch. You're just not talking about -- you're not talking about specifically rebate accounting, you're talking about your actual GAAP accounting will reflect that exchange in next year as well?

Robert A. Waegelein

That’s right, as quality expenses improving health outcomes activities prevent hospital admissions, IT improvements that is liable to be put into the MBR lines, so we want to give you a sense of what that would have been in 2013, and you could expect the similar ratio in 2014.

Kevin Fishbeck – Bank of America Merrill Lynch

Okay. And so, I'm sorry, this would be 180 basis points on the entire Company, or 180 basis points within the MA MLR?

Richard A. Barasch

MA.

Kevin Fishbeck – Bank of America Merrill Lynch

MA, okay. And then just wanted to clarify, because the wording in your commentary around the 2014 bid said that your commenting on your 2014 bids, and then you went on to say assuming that you made progress on medical management? Is there -- how much of what you're assuming as far as medical management is kind of the normal execution that you would have, or are you assuming something extra happens?

Richard A. Barasch

We’re not assuming anything, we’re assuming a normal progression and improvement.

Kevin Fishbeck – Bank of America Merrill Lynch

Okay. And then the home risk assessment commentary, would you say that -- obviously it seems to me like the ability to get that same appropriate coding done would be easier in an environment where you have a capitated contract where the physicians are just as incentivized as you are to make sure the coding is accurate. Is that -- do you agree with that statement, that it will be easier to find offsets in more capitated and contracts where you have better efficient alignment than in more open network products?

Richard A. Barasch

Absolutely, that’s there are – I think that’s a very, very accurate statement.

Kevin Fishbeck – Bank of America Merrill Lynch

Okay. But was the home risk assessment that you guys did skewed towards the probably the PPO business, because it was hard to get them onboard in the first place? Or was it a broader thing done throughout the company?

Richard A. Barasch

It was pretty broad, but your close comment is correct. I think that we have more tools to the extent, this theory, this thesis persuades everything I said, which is, of course, to your physicians the more likely you are to get plus, plus, plus, plus in every major including revenue.

Kevin Fishbeck – Bank of America Merrill Lynch

Okay. Thanks. And just to go back to the commentary about the phase in of the star bonus, can you go over exactly what in the reg does that?

Richard A. Barasch

Basically in six-year facing counties and that constitutes a good number of our core counties. You only get based on the current reading and demand there is more to be done on this. They only get the star improvement on the portion that’s already been faced in. So it’s approximately two-thirds of the facing to get approximately two-thirds of the stars.

Kevin Fishbeck – Bank of America Merrill Lynch

Okay, thisis Upstate New York?

Richard A. Barasch

Well, it’s also in our Houston too.

Kevin Fishbeck – Bank of America Merrill Lynch

Okay.

Richard A. Barasch

Yes, but again, I wanted to make a really important point here. This is not Universal American specific. I think with every – people need to always understand about Medicare advantage is that it’s a relative conversation and each plan in each market has fundamentally the same rate issues around it.

There are a lot of Medicare advantage plans around the country that are charging premium and doing it successfully, that’s just the market allows in those areas. And we are not signaling we’re going to change our premium structure just making the point that there wasn’t some areas that’s been working other large – it’s a relative conversation and market by market.

Robert A. Waegelein

And Kevin just I heard you said Upstate New York about half of the member in Upstate New York is already at the benchmark and we will see before bonus?

Richard A. Barasch

Yes, so it’s – so I just…

Kevin Fishbeck – Bank of America Merrill Lynch

[Indiscernible]

Richard A. Barasch

Yes.

Kevin Fishbeck – Bank of America Merrill Lynch

Okay, great, thanks.

Richard A. Barasch

But having said that there is still a lot more revenue than we would have gotten and a lot more revenue than our competitors we did not get the same star rating.

Kevin Fishbeck – Bank of America Merrill Lynch

Okay, great, thanks.

Operator

Thank you. Our next question is coming from Anna Gupte of Leerink Partners. Please proceed with your question.

Anna Gupte – Leerink Partners

Hi, thanks, good morning. So the first question, I wanted to follow up on Matt's question about Medicare cost trends in the fourth quarter. There has been some commentary about -- at least from one of your competitors around facility based coding creep? I was just trying to understand how the economics you're working with your providers, and if there's anything that's differentiated about your network and how you're sharing the upside from star?

And then possibly passing through in 2013 sequestration? And then going forward into 2014 there's obviously a lot of headwinds. And are you seeing any kind of coding creep? That's the bottom line. Are you seeing coding creep because of it?

Robert A. Waegelein

Let me start with that is, one of the unfortunate and not productive aspects of what we all do is fight this provider coding battle on a constant basis. And frankly ICD-9 is going to ramp that up even more, it’s going to be interesting. ICD-10, sorry, Bob I think I was around for ICD-3, so I have to keep reminding myself what this is. But the – it’s always a problem. And it’s – with providers then and payers – it’s a coding and fighting back on coding.

So that’s just could you just commentary as to what – or we will – we do our jobs when we reduce hospitalization and we further do our jobs when we make the hospitalizations as efficient as possible in the context of quality care. So we’re – last year we’re unfocused on after their facilities were focused, highly focused on them, but we’re much more highly focused on them, but we’re much more highly focused on the reducing admission and readmission. And in our general – we’re a very few if any facilities to participate in our share gain programs.

Anna Gupte – Leerink Partners

Okay. So it doesn't sound like you're seeing net net that much, and you still feel that you're reducing volumes and not so much -- the focus is not on cost per claim, but you're doing it with nothing out of the ordinary?

Richard A. Barasch

It’s both, it’s both. We have got our efforts to make sure we’re paying our clients fairly but our major effort is on – is on getting folks to access the healthcare system in the more sufficient way.

Anna Gupte – Leerink Partners

Got it. Okay. Then another question to follow up on the economics of accountable care and your ACO model, and pardon me if you've already gone through this in detail. I've just picked up coverage of your name. As I understand, you're looking at this not just for MA but also fee for service? So why don't you understand -- yes, sorry.

Richard A. Barasch

I mean this is a pretty long explanation, we happy to take those offline if you explain it some detail. But the Medicare ACO program has built on fee-for-service. So you’ve got fee-for-service rates and fee-for-service roles and what needs to be done inside of the ACO is reduced costs under those both constraints and helps. There we don’t have contracting issues sales and marketing as far as things that don’t occur in the ACO that – in the ACO and that do occur in MA.

But at the end of the day, you have got to be – sort of the punch line is out ability to work with primary care physician to reduce cost and increase quality. So it’s – so on the ground, it’s the same set of techniques that’s just built inside of the different chassis. But I was saying before about the RFI is the peers that the CMS and the administration is going to consider moving the ACOs from our shared gain sort of construct to a more full risk construct which we welcome. It won’t being necessarily Medicare advantage but it will be something in the middle more geared toward the fee-for-service rules.

Anna Gupte – Leerink Partners

Okay. Just to wrap it up, and for me put the finer point on it, so sounds like it's about $70 or something potentially per member? That's 3,000 provider chassis. Can you give us a ballpark estimate of how many members it would support? So with your current network…

Richard A. Barasch

It’s more than 3,000 members in our ACOs at this point. So you know the – we haven’t really exposed anything other than pro forma math on this.

Robert A. Waegelein

And feel free to give me a call later today to give you…

Anna Gupte – Leerink Partners

All right…

Robert A. Waegelein

A little more story along the ACOs, okay.

Anna Gupte – Leerink Partners

Thanks, all right thank you, Bob. Thanks Richard.

Operator

Thank you. Our next question is coming from Carl McDonald of Citi. Please proceed with your question.

Carl McDonald – Citigroup Global Markets

Great, thanks. So I had a couple more SG&A questions. The first one is mechanical to think about the right starting point. So if we're losing, call it, almost 2% for the quality initiatives, then there's also the industry fee that pushes it up, call it a percent and a half. So is it right to think about the starting point as we head into 2014 being something in the 14.5% vicinity?

Richard A. Barasch

We’re going to report the separately there is being inline that really call it out, so we won’t be referring to that as ALR rate.

Carl McDonald – Citigroup Global Markets

Got it. Okay. And then just the second broad question on the SG&A improvements. How much of the target improvement for 2014 is going to come from new initiatives versus some spending that you're currently doing that you don't think is going to continue at the same rate? So as an example…

Richard A. Barasch

It’s good. It’s a great question, all a bit above, I mean a lot of the spending, if the increase spending in the past has been targeted toward quality in source. We will never stop making the appropriate expenditures, but we have a risk, I am not back that moving from three stars to four stars in the Northeast plants was not simple, hard and by a lot of work in all lot of expense.

We will have to replicate a bunch of that expense going forward because we have program and processes in place to make that more regular part of our business. So I think some of it is just purely having spend a bunch of money being able to spend less on some of same stock, another big piece of its is efficiencies. One of the somethings about getting more efficient it actually less expensive to be more efficient, so that there is sort of current good news in that, then there will be a chuck of stop that we, that we have to do that would always call be problematic which fundamentally change in some of the way which we doing business.

Carl McDonald – Citigroup Global Markets

Do you want to put any numbers around that, in terms of half and half, or 25/75?

Richard A. Barasch

Hard to do that call.

Carl McDonald – Citigroup Global Markets

All right. Thank you.

Richard A. Barasch

Thank you.

Operator

Thank you. (Operator Instructions) Our next question is coming from Scott Fidel of Deutsche Bank. Please proceed with your question.

Scott Fidel – Deutsche Bank

Thanks. First question, just how are you guys thinking about trajectory of operating margins for the MA business in 2014 relative to 2013? Obviously a bunch of pushes and takes. You got the ability to improve off of some of the poor performance in 2013, but you got new headwinds from some of the ACL and then so. First just operating margins, excluding the ACA fee and then help us think about the impact of the ACA fee on net margins for the business in terms of the impact on the tax rate and just how much you feel that you ended up solving for the industry fee in the MA business?

Richard A. Barasch

Big set of question there Scott, so let me see if I can break them apart. As you know, we’re not giving guidance, so I just – I don’t want to sort of back in the guidance with some data points. But we’re – we’ve been doing any bids for a long time. We’re not perfect, we’ve made some mistakes, but we feel pretty confident that given the way 2013 and the 2014 on a loss ratio basis is, it’s going to be sort of in line with sort of how we’re thinking about it, gliding up to the 85 included in the 180 basis points.

So we’re – we feel that we’ve got a pretty good shot at staying in the fair way on Medicare medical benefits. There is – we probably – we’ll get hurt a little bit, because we maybe – I don’t know what our competitors did, but we kind of though that sequester will be over by now, so it was probably a little bit about headwind on that.

So given everything and given how we think about this business is sort of kind of slogging through by the way and slogging through and continuing to grow. By the way this is really important question, made this point in my prepared remarks, with all the headwinds, the product continues to grow. And the contention I make and I still make is that there is a huge amount of data value being given by these plans to their members that aren’t just embody in premium rate and co-pay.

So I think the fact that the program still gross, it’s pretty important. The program can’t absorb headwinds constantly and continue to grow and 15 it’s got some tough elements to it, but the consumer acceptance of these programs is pretty high. So just you’ve given your segway to say that I meant to say that before.

So, now really if you sort of take the view for us that our – we’ve got our kind of risk management loss ratio piece and again I don’t want to overstated, I don’t want to lay any issues that in spite some flues and hospital over coating and so forth. If you assume that have that relatively enhance, our big issues are expenses. And that’s just what we’ve got to focus on.

Scott Fidel – Deutsche Bank

Okay. And when you take all those pieces together, Richard, is your view that the MA business on an after-tax basis will be profitable in 2014?

Richard A. Barasch

Yes, I mean it’s profitable last year, there's no reason why it shouldn't be profitable this year.

Scott Fidel – Deutsche Bank

Okay. And then just one last question, just on the concept about not providing guidance at this point, and I know that in the recent past it's really been the uncertainty around the ACO flows, and clearly that's still an issue that continues. Is that really the key issue still at this point, or is it just more broadly at this point, just given all the flux on the MA business as well?

Richard A. Barasch

I think it’s a broad issue, I think the ACOs make it easy to make that decision. But sort of going and doing guidance and I give my peers a lot of credit for their predictive abilities. We see a market more in flux and less amenable to sort of some of the predictive stuff that we’ve done in the past.

I don’t – I think that you can expect at some point we’ll be back talking with guidance and or even or maybe not specifically, but with more guiding numbers to help you guys. But right now, given the transitional phase of the company, giving the uncertainties around APS, given some of sort of the ACO stuff, I’m happy to talk about the company, but to sort of stick a number on back end of it is not appropriate for us at this point.

Scott Fidel – Deutsche Bank

Okay. All right. Thank you.

Operator

Thank you. Our next question is coming from Tom Carroll of Stifel Nicolaus. Please proceed with your question.

Tom A. Carroll – Stifel, Nicolaus & Co., Inc.

Hey, good morning, guys. Just would you comment further on how you see APS contributing longer-term? It sounds like there may be some opportunity in Puerto Rico, but just maybe a little more commentary on your vision there? Is this a non-starter from here, or is this an area that could contribute more meaningfully longer term?

Richard A. Barasch

Well, I mean that’s – we’re – we had to strip this thing down to the core. And in the core there is some good contracts. There is some – and these are contracts – and I said this in my prepared remarks, I’ll say it again. Despite all the financial issues we’ve had with APS despite the litigation and so forth, companies committed to providing the highest level of service to fairly sizable number of clients, but stay in health plan that we’ve got.

So, kind of put that in – that’s kind of answer number one to that question. Answering number two is, we really do have to evaluate where this fits in with us both strategically and financially. And as Bob mentioned, we think we’ve got ways to kind of minimize the loss further – lower down than the $8 million to $10 million that we lose – that we lost in 2013. A lot of that is just frankly just brute force.

Also – but we have to consider, sort of how this fits with us going forward. Puerto Rico, that’s an interesting opportunity because we got an infrastructure down there that should be useful to somebody, who is a direct bidder for that program. So we’re – it’s a company that’s not without its attributes, but the question is where it fits on an overall basis with our ongoing strategy.

Tom A. Carroll – Stifel, Nicolaus & Co., Inc.

In Puerto Rico, might you sell those assets to one of the existing players down there?

Richard A. Barasch

We’re open to conversation about any and all aspects of that business.

Tom A. Carroll – Stifel, Nicolaus & Co., Inc.

And then what amount of revenue could APS produce in 2014 with the just existing contracts that you have in place?

Richard A. Barasch

Yes. Again, we’re not providing guidance, but at some point maybe we could be a little bit more transparent about that, but not at this moment.

Tom A. Carroll – Stifel, Nicolaus & Co., Inc.

Is it half what it was, I mean some order of magnitude?

Richard A. Barasch

Depends on how – look, Puerto Rico was half of the revenue, now the risk contract, it’s going way on June 1 – July 1 rather. Even if we maintain a contract, there will be less revenue, may not be less profitable, but it will be less revenue. The other part of the revenue, which was the fee-based revenue drop substantially from a 2011 to 2013.

Tom A. Carroll – Stifel, Nicolaus & Co., Inc.

Okay. Thank you very much.

Operator

Thank you. At this time I would like to turn the floor back over to management for any additional or closing comments.

Richard A. Barasch

Thanks, everyone. I appreciate your participation in this call, obviously and always Bob, Adam and I are available for any questions. I assume the supplement has been posted, so there is all the information that you are used to seeing from us. I appreciated the time this morning, happy to answer any other questions, and look forward to this being the trough and for us to build very smartly going forward.

So thanks all of you, and have a good day.

Operator

Ladies and gentlemen thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines at this time, and have a wonderful day.

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