Aetna's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.24.14 | About: Aetna, Inc. (AET)

Aetna, Inc. (NYSE:AET)

Q1 2014 Earnings Conference Call

April 24, 2014 08:30 am ET

Executives

Mark Bertolini – President & Chief Executive Officer

Shawn Guertin – Executive Vice President, Chief Financial Officer & Chief Enterprise Risk Officer

Tom Kelly – Vice President, Investor Relations

Analysts

Carl McDonald – Citi Investment Research

Josh Raskin – Barclays Capital

Justin Lake – JP Morgan

Peter Costa – Wells Fargo

Scott Fidel – Deutsche Bank

Christine Arnold – Cowen and Company

Ralph Giacobbe – Credit Suisse

Ana Gupte – Leerink Partners

AJ Rice – UBS

Matthew Borsch – Goldman Sachs

Kevin Fischbeck – Bank of America Merrill Lynch

Chris Rigg – Susquehanna Financial Group

Sarah James – Wedbush Morgan Securities

Dave Windley – Jefferies & Co.

Michael Baker – Raymond James

Tom Carroll – Stifel Nicolaus

Operator

Good morning. My name is Jenny and I will be your conference facilitator today. At this time I would like to welcome everyone to the Aetna Q1 2014 Earnings Call. (Operator instructions.) As a reminder, this conference is being recorded. I would now like to turn the conference over to Tom Kelly, Vice President of Investor Relations. Mr. Kelly, please go ahead.

Tom Kelly

Good morning, and thank you for joining Aetna’s Q1 2014 Earnings Call and Webcast. This is Tom Kelly, Vice President of Investor Relations for Aetna, and with me this morning are Aetna’s Chairman, Chief Executive Officer and President, Mark Bertolini; and Chief Financial Officer, Shawn Guertin. Following the prepared portion of the remarks we will answer your questions.

During this call we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in this morning’s press release and the reports we file with the SEC including our 2013 Form 10(k).

We have provided reconciliations of metrics related to the company’s performance that are non-GAAP measures in our Q1 2014 financial supplement and our 2014 guidance summary. These reconciliations are available in the Investor Information section of www.aetna.com.

Please note that the inclusion of Coventry’s business in Q1 2014 results impacts the quarter-over-quarter comparisons. Additionally, all references to 2014 operating earnings and operating EPS reflect Aetna’s current definitions which exclude amortization expense related to acquired intangible assets.

Finally, as you know, our ability to respond to certain inquiries from investors and analysts in non-public forums is limited so we invite you to ask all questions of a material nature on this call. With that I will turn the call over to Mark Bertolini. Mark?

Mark Bertolini

Good morning. Thank you, Tom, and thank you all for joining us today. On prior calls we have discussed 2014 as a year with many challenges, including solving for ACA-mandated fees and taxes and offsetting the rate pressures in the Medicare Advantage program. Overcoming these challenges in Q1 has required a clear strategy, the power of a diversified portfolio of business, and above all strong execution.

As a result, this morning Aetna reported record quarterly operating EPS of $1.98 per share, a 27% increase over the prior year quarter. Underlying this result we grew medical membership by over 500,000 members, reaching over 22.7 million members. We grew quarterly operating revenue by 47% from the prior year, reaching $14 billion and we grew quarterly operating earnings by 40% from the prior year, reaching $722 million. Each of these quarterly metrics represents historic highs for our organization.

Based on our Q1 results today we made several adjustments to our full-year 2014 guidance. We increased our projected full year operating revenue to a range of $56 billion to $57 billion, representing at the midpoint projected year-over-year growth of nearly 20%. We instituted year-end membership guidance of over 23 million medical members, projecting between 800,000 and 1 million members of growth for 2014, and an incremental 300,000 to 500,000 members of growth for the remainder of the year.

And we raised our operating EPS projection to a range of $6.35 to $6.55 per share from our previous projection of at least $6.25 per share. At the midpoint Aetna is now projected to grow operating EPS at a compound annual rate of 14% since 2010, well in excess of our managed care peers.

We are pleased with our Q1 performance and our updated 2014 outlook. While uncertainties remain the power of Aetna’s diversified portfolio, an enduring commitment to maintain our pricing discipline, continued progress on the Coventry integration and solid execution gives us increasing confidence that we can achieve our 2014 projections.

At our Investor Conference in December we highlighted the following elements of our growth model built on the strength of our diversified portfolio of businesses. Specifically we project that Aetna’s large group commercial business can grow profitably, Aetna’s government business can be a growth engine. Small group and individual represent an opportunity for future growth. Next generation networks enhance the core business and Coventry is highly accretive, enhances top line growth and strengthens our capital position.

I will now provide a brief update on how we are executing against some of these growth levers. Starting with our large group commercial business, we grew nearly 300,000 members in our large group commercial business in Q1, predominantly through self-insured membership increases. These gains were attributable to new customer wins in public and labor, continued growth in our network access products and new, private exchange membership. We are pleased with this result and our continued prospects for growth for the remainder of 2014.

In our government business we had another notable quarter of new sales in Medicare Advantage, adding over 130,000 members in the quarter. Our continued momentum speaks to the popularity of the Medicare Advantage program and the value we provide relative to traditional fee for service Medicare. This value is demonstrated by our STARS performance where we have a higher percentage of members in 4-STAR or greater plans than any of our national managed care peers. We continue to invest in our Medicare Advantage business and project that our STARS performance will improve in 2015, further enhancing our value proposition.

Moving on to the final 2015 Medicare Advantage rates, Medicare Advantage continues to be a highly successful program with nearly 16 million Americans or 30% of the Medicare population relying on the value that this program provides. We were encouraged that the final rate notice demonstrated a commitment on the part of CMS to mitigate the funding pressures outlined in the advanced notice. However, with the final notice it is clear that rates for this popular program will decline once again. When combined with last year’s rate action this will represent a high-single digit decline over the 2014 and 2015 period.

Despite our efforts these continued funding cuts may drive increased member disruption in 2015, including more meaningful increases to premiums, lower benefits, and even market exits. Aetna remains committed to the Medicare Advantage program and we will continue to work to enable our members to better manage their health, enhance the quality of our products, preserve member benefits and earn an appropriate return for our shareholders.

Continuing with the government business, our Medicaid franchise performed well in Q1 producing strong operating results and growing by over 60,000 insured members during the quarter. Additionally on April 1st in the partnership with Mercy Maricopa Integrated Care we began serving over 600,000 behavioral health members through one of the largest integrated behavioral health contracts in the nation. Note that these members will not be included in our medical membership counts.

Finally, we expect that we will begin enrolling dually-eligible members through both our Ohio and Illinois demonstration projects beginning in Q2. We are pleased with the execution and momentum in our Medicaid products and look forward to serving these additional members in 2014.

Moving on to our individual business, despite some initial challenges with the launch of the public exchanges enrollment has continued to build through the end of the open enrollment period. At the end of Q1 Aetna had 230,000 paid public exchange members included in our reported results. Based on our experience to date, we now project we could end the year with approximately 450,000 paid public exchange members.

At this early stage we do not have enough experience with this on-exchange population to draw meaningful conclusions as to their overall health status. However, we would note that in the aggregate our early medical cost indicators for this population remain within a manageable range as compared with our pricing assumptions.

As we think about the individual business it is important to put it into the proper context for Aetna. We now project that our combined on- and off-exchange individual business will represent approximately 5% of our 2014 operating revenues and continue to project that it will be a modest headwind to operating earnings in 2014. This projected result is consistent with our strategy to gain meaningful early experience in the on-exchange marketplace and still represents a manageable financial exposure for Aetna that is contemplated within our updated guidance range.

Looking forward, as we prepare to submit our 2015 on-exchange bids our bias is to maintain our current footprint across 17 states. While each rating area within a state has distinct demographic and competitive dynamics, at a high level we are evaluating our projected medical cost experience with this population, the risks and uncertainties of recent public exchange regulatory changes, and the pricing levels necessary to achieve reasonable returns on capital for our shareholders.

Our teams are hard at work evaluating these critical criteria and weighing the risks and benefits of our continued participation and the appropriate pricing for each separate weighting area. We look forward to updating shareholders on the outcome of our deliberations as we move throughout the year.

Shifting to our ACL and next-generation network strategy, we continue to execute on our strategy of enabling providers to transform their models from episodic acute care management to population health management. By aligning economic incentives between Aetna and providers we are able to offer high-quality, low-cost products, enhancing the growth of our core businesses.

Our Innovation Health joint venture with Anova Health in Virginia speaks to the power of these relationships. Powered by Anova’s high quality of care, integrated clinical model and attractive cost structure, we have been able to win a 30,000 member public and labor account in Virginia, offer attractively priced individual public exchange products to over 8000 new members, and attract interest from a number of Fortune 500 companies in accessing this high-quality network for their employees.

In total we now have more than 100,000 members enrolled in Innovation Health plans, a figure we expect to continue to grow. By partnering with providers like Anova we are creating a scalable, capital efficient model that enables true population health management, ultimately creating a healthier world one community at a time.

Finally, a few comments about our long-term growth outlook: at our Investor Conference in December we outlined our long-term growth strategy, backed by the strengths of our diversified portfolio and the many growth opportunities we believe we have before us.

Our growth in Q1 across multiple businesses speaks to these growth opportunities as we added 130,000 private exchange members, of which over two-thirds are fully insured; enrolled approximately 230,000 paid members through the public exchanges; grew our Medicare Advantage membership by over 130,000 members, expanded our Medicaid Risk membership by over 60,000 members; and further expanded our presence in the international private medical insurance marketplace by closing the InterGlobal acquisition earlier this week.

Collectively, we project these new members to contribute over $3 billion in annual premiums and fees and represent an encouraging start as we seek to double operating revenues by the end of the decade.

In summary I am pleased with our Q1 results and I am confident in our strategic direction and our ability to execute, our continued pricing discipline across all lines of business, our ability to achieve Coventry synergies and our accretion goals, the power of our diversified portfolio to drive growth, and our 2014 operating EPS guidance of $6.35 to $6.55 per share.

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

I will now turn the call over to Shawn who will provide additional insight into our Q1 results and our updated 2014 outlook. Shawn?

Shawn Guertin

Thank you, Mark, and good morning everyone. Earlier today we reported record Q1 2014 operating earnings of $722 million and operating earnings per share of $1.98. Aetna’s operating results continue to be supported by strong revenue growth, cash flow, and operating margins. I’ll begin with some comments on overall performance.

Our top line performance for the quarter was very good. We grew operating revenue by 47% over the prior year quarter to a record quarterly level of $14 billion driven by the Coventry acquisition and underlying revenue growth. We also grew medical membership to a record 22.7 million members, adding over 525,000 new members during the quarter with growth in our commercial self-insured and government businesses. Q1 2014 represents Aetna’s eighth consecutive quarter of medical membership growth.

From an operating margin perspective our businesses are performing quite well. Our pre-tax operating margin was 9.5%, a 50 basis point year-over-year improvement and at the high end of our target operating margin range. Our Q1 total medical benefit ratio was 80.4%, a strong seasonal result that benefited from actions designed to solve for ACA-mandated fees and taxes, favorable prior years’ reserve development, harsh winter weather and a moderate flu season.

Our operating expense ratio was 17.8%, a 20 basis point improvement over Q1 2013 as growth in operating revenue, a disciplined focus on cost, and Coventry synergies more than offset the negative impact of ACA-mandated fees on this metric.

From a balance sheet perspective we remain confident in the adequacy of our reserves. We experienced favorable prior years’ reserve development in the quarter across all of our core products, primarily attributable to Q4 2013 dates of service. Our reserve growth well exceeded our premium growth and days’ claims payable were 47 days at the end of the quarter, up two days sequentially. This increase in days’ claims payable was driven primarily by new membership in the quarter, including our new public exchange membership. As Risk membership growth levels out over the balance of the year we expect this metric to return to a level more consistent with our recent historical experience.

Turning to cash flow and capital, operating cash flows in Q1 were strong. Healthcare and group insurance operating cash flows were 2.1x operating earnings driven by higher premium receipts resulting from pricing actions designed to recover ACA-mandated fees and taxes and the growth in insured membership in Q1. We also continue to aggressively deploy capital to create shareholder value, repurchasing over 6.5 million shares in the quarter for $465 million and distributing another $82 million through our quarterly shareholder dividend.

In short, we are very pleased with our Q1 results which we believe demonstrate the execution of Aetna’s growth strategy, the success of the Coventry integration, and the value of our diversified portfolio. I will now discuss the key drivers of our Q1 performance in greater detail.

Beginning with our Commercial business, our commercial membership growth significantly exceeded our projection during the quarter, growing by over 400,000 members. This growth was almost entirely driven by commercial self-insured membership gains as commercial insured membership was flat sequentially. Given the numerous moving pieces I will discuss each of the component parts separately.

Starting with commercial self-insured medical membership we grew by just over 400,000 members in the quarter driven by new customer wins in the public and labor and network access products. Additionally, we recently announced that we will add over 400,000 new commercial self-insured members associated with the Teacher Retirement System of Texas starting on September 1st. Commercial self-insured membership also benefited as a result of a large customer transition that was projected to occur in Q1 but that has been delayed until at least Q2 2014. Given the TRS contract win we are confident that we will grow self-insured membership over the remainder of the year.

Moving on to commercial insured, membership was flat sequentially, a result that speaks directly to our commitment to fair and financially responsible pricing where we favor margin over membership and price to underlying medical cost trends. This result was primarily driven by two items – individual membership grew by approximately 100,000 members as new public exchange enrollees more than offset declines in our off-exchange enrollment. However, this new exchange enrollment activity was offset by the loss of membership in limited benefit products, reducing membership in the quarter by approximately 100,000 members.

As we examine the remainder of the year we project that continued on-exchange membership growth will more than offset remaining lapses in our limited benefit membership, and therefore project that commercial insured membership will increase over the balance of the year.

Our commercial medical benefit ratio was 77.2% for the quarter, an excellent result. This result benefitted from both higher premiums driven in part by pricing actions designed to recover ACA-mandated fees and taxes, strong prior years’ reserve development, the favorable impact of harsh winter weather, and a moderate flu season. Excluding these items, Q1 underlying commercial medical cost trends are emerging consistent with our previous projections. Based on our year-to-date experience we continue to project that Aetna’s standalone 2014 commercial medical cost trends will be in the range of 6% to 7%.

Another important growth lever is our government franchise. Our government business grew by over 120,000 members in the quarter consisting of Medicare Advantage growth of more than 130,000 members, Medicare Supplement growth of over 30,000 members, and Medicaid Insured growth of more than 60,000 members; partially offset by the previously disclosed exit from a low-revenue Medicaid [ASC] contract in California accounting for 125,000 members.

The Coventry acquisition combined with strong underlying membership growth drove Q1 2014 government premiums to a record $5.1 billion, nearly double Q1 2013. Our government medical benefit ratio was 84.7% in the quarter, an excellent result in absolute terms and a year-over-year improvement of over 300 basis points. Drivers of this year-over-year improvement include actions impacting revenue and medical costs designed to solve for the Medicare Advantage funding gap including the health insurer fee; increased favorable prior years’ reserve development; and the favorable impact of harsh winter weather and a moderate flu season.

Moving on to the balance sheet, our financial position, capital structure and liquidity all continue to be very strong. At March 31sr we had a debt to total capitalization ratio of 36.5%. Looking at cash and investments at the parent, we started the quarter with $200 million, net subsidiary dividends to the parent were $486 million. We repurchased over 6.5 million shares for $465 million and paid a shareholder dividend of $82 million. After other uses we ended the quarter with $100 million of cash at the parent, representing our core liquidity. Our basic share count was 357.4 million at March 31st.

As a result of our Q1 performance we are increasing our 2014 operating earnings per share guidance to a range of $6.35 to $6.55 per share. At the top end of the range our guidance has increased by $0.30 driven by favorable operating performance and volumes in Q1 2014 including the effect of favorable prior years’ reserve development, weather impacts and a moderate flu season, partially offset by increased levels of strategic spending in 2014 including additional actions to solve for the Medicare Advantage funding gap, investments in healthcare management, and investments in our consumer-centric and population health strategies.

However, at this early stage in the year certain risks and challenges remain, and the bottom end of our projected range reflects these uncertainties, including the ever-present concern that medical cost trends could increase more than we’ve projected including but not limited to the potential for higher-than-projected utilization of new Hepatitis C treatments; current low visibility associated with our public exchange membership given the immature medical cost experience we have on this cohort, particularly in light of the late surge in enrolment; and the risk that our new Medicare Advantage membership will be less profitable than currently projected.

Our updated 2014 guidance is also influenced by the following additional drivers: we project that our full-year medical membership will be over 23 million members, an increase of 300,000 to 500,000 members over the remainder of the year. Drivers of this projected increase are continued growth in commercial and Medicare membership, Medicaid expansion and the inclusion of membership from our recently closed acquisition of InterGlobal.

Based on our full-year membership projections we are increasing our full-year 2014 operating revenue projection to a range of $56 billion to $57 billion. We continue to project our full year commercial medical benefit ratio to be 79% to 80% and our full year government medical ratio to be 85% to 87%, noting that our updated guidance implies relative improvement inside our guidance ranges.

We now project our operating expense ratio will be approximately 18.5% as higher volumes enhance operating leverage. We continue to project pre-tax operating margin to be at least 7.5%, consistent with our high-single digit target. We now project operating earnings to be approximately $2.3 billion.

Based on our increase in operating revenue guidance we now project net dividends from subsidiaries to be approximately $1.7 billion as additional capital to support premium growth is held at our regulated subsidiaries. We continue to project excess cash flow to the parent of approximately $1.2 billion.

Finally, as we examine the progression of quarterly earnings for the remainder of the year we project that Q1 will be the highest one for operating earnings per share. This projection is consistent with the high level of prior years’ reserve development in Q1, the typical seasonal pattern of medical costs, and an operating expense ratio that we project to increase over the course of the year. As a result we project that our Q4 operating EPS will be the lowest result of this year.

In closing, we are encouraged by the strength of our Q1 results and our improved 2014 outlook, particularly at this early stage in the year. As we look to the rest of the year we remain focused on delivering on our plans to offset the Medicare Advantage rate pressures, integrating Coventry as we continue to invest to achieve or exceed our 2014 synergy targets, collecting or solving for the ACA-mandated fees and taxes, and executing on our exchange strategies both public and private.

As we continue to execute on these key focus areas during this challenging time for our industry we are increasingly confident that we can achieve our 2014 projections, meeting our goal to grow both operating earnings and operating EPS this year. I will now turn the call back over to Tom. Tom?

Tom Kelly

Thank you, Shawn. The Aetna Management Team is now ready for your questions. We ask that you limit yourself to one question so that as many individuals as possible have an opportunity to ask their questions. Operator, the first question, please?

Question-and-Answer Session

Operator

Yes, we’ll go first to Carl McDonald with Citi.

Carl McDonald – Citi Investment Research

Great, thank you. I was hoping that you could quantify as best you can the impact of weather and also the net favorable development on earnings in Q1.

Shawn Guertin

Carl, what I would say is if you put those two items actually together which would include also a more modest flu season than we had projected, that’s probably a $0.45 good guy.

Carl McDonald – Citi Investment Research

Great, thank you very much.

Operator

And we’ll go next to Josh Raskin of Barclays.

Josh Raskin – Barclays Capital

Hi, thanks, good morning. Based on the comments from United last week I was wondering if you guys could update your thoughts on how the early renewal process went in your commercial risk book, and then any expectations for what we’ll call the ACA-compliant plans that signed up or groups that signed up after January 1st, and any thoughts around the risk pool for the remaining risk accounts that signed up in Q1?

Mark Bertolini

Yeah, Josh, we started working on healthcare reform back in 2010. We put together a PMO, over 350 people that focused on the mechanics of how to think about this pricing, and so we fully anticipated that with early renewals, which was a strategy we adopted earlier, and with the potential for ACA-compliant plans that there was going to be definite risk shift in the pools. And we priced for that in our pricing models.

So at this early point, absent more data on the underlying experience of this population we feel we are priced appropriately for both early renewals and for the ACA-compliant plans at this time.

Josh Raskin – Barclays Capital

And so Mark, just on that just specifically, relative to your previous expectations did the early renewal process meet those expectations; i.e., did you see more or less of those early renewals? And then any change in thought relative to say three months ago as to what that existing pool looked like when you did get into Jan. 1?

Mark Bertolini

We saw a little more than we expected – about a third of the book was early renewal which we were expecting 25% to 30%, somewhere in there. So I think at the end of the day we had a little bit more but not meaningfully more number one. Number two, as we look at going through this year that “keep what you have” has been extended. We’re obviously going to reflect that in our pricing which will have a meaningful impact on our pricing as we go into 2015.

Josh Raskin – Barclays Capital

Okay, perfect. Thanks.

Operator

And we will move to our next question from Justin Lake of JP Morgan.

Justin Lake – JP Morgan

Thanks, good morning. My question, Shawn, you mentioned Medicare Advantage and new membership as an area of uncertainty, specifically on what the margins are going to look like. Can you walk us through what new Medicare Advantage membership margins look like typically for new members and then what you’re seeing with early experience on the new membership for 2014 in terms of the potential for adverse selection and other uncertainty?

Shawn Guertin

Yes, I would say that typically the new membership will be profitable but not as profitable as what I call sort of the mature book or the overall book. That was our outlook a quarter ago, and we didn’t see anything different in Q1 that would make us feel any different about the performance of that membership as evidenced by the very good government MBR that we posted for the quarter. But again, it is early and before we would declare victory on that we’d like to see a little bit more experience.

Justin Lake – JP Morgan

So we should have an idea of kind of how that shakes down maybe by the time you report Q2?

Shawn Guertin

Yes. I think we will definitely have better insight at that point.

Justin Lake – JP Morgan

Okay, great, thank you very much.

Operator

And we’ll hear next from Peter Costa of Wells Fargo.

Peter Costa – Wells Fargo

The weather, flu and prior period development were all a good guy – you said $0.45. It made your loss ratio also look quite good compared to what your guidance is, yet you left your medical loss ratio guidance alone and you didn’t raise your earnings guidance by as much as the $0.45 [fee]. Can you talk about what other incremental costs you’re expecting relative to what you were expecting before? And if that’s Hep C can you kind of quantify what that was in Q1 for you guys in terms of costs?

Mark Bertolini

Peter, I’ll answer the broader question and I’ll ask Shawn to talk about the specifics of Hep C. But in the end announcement, if you think about the $0.40 to $0.45 on prior period development, weather, flu, the offsets we see to that is based on what we’re seeing in the 2015 Medicare rates. Our anticipation is that we should start investing now so we will think about an investment portfolio of $0.10 to $0.15 the remainder of the year that’s going to be aimed at getting ready for Medicare, getting some more of our Medicaid dual eligible populations up, and to think about the private exchange investments that we would have to make. And so that would be an offset to that.

And then Sovaldi going to be a headwind. Let me turn it over to Shawn and he can talk a little bit about Sovaldi and Hep C.

Shawn Guertin

Yes, Sovaldi as some of you mentioned in your pre-call notes, we didn’t talk about that a lot in the press release and that is because largely for us in Q1 it came in right around what we had built in for Q1. Now having said that, there was a delayed ramp in some of our segments of business so I’ll call that it was a bit of an artificial hit planned because there was a bit of timing delays. And when we look at the run rate we would expect, and our guidance contemplates that we will actually have more expense related to this item during the rest of the year.

I want to point out though that again, even with this item in isolation which will be a strain, our outlook for the full year is still intact as far as our outlook on trend and the MBR. The majority of what we saw in Q1 on Sovaldi was in our commercial business and our Medicare business and a very small amount in Medicaid, and again, to some extent that’s an outgrowth of the timing of various Medicaid plans covering this. Some of our Medicaid plans have carved out pharmacy as well; some of them we don’t have any exposure.

So overall we look at this as one of the strain items that could potentially be there, but I’ll take you back and try to wrap up Mark’s question, too. You talked about the positive items being $0.45. A simple way to think about this is the investment that Mark talked about which we think is appropriate for the future maybe takes $0.15 off of that. That takes you to $0.30; that’s the top end of our range. To the bottom end you have the risk factors I mentioned in my remarks, clearly one of which is Sovaldi.

Peter Costa – Wells Fargo

That’s very helpful. And is there any way you could quantify the number of Hep C patients that you had in the quarter or the expense you had in the quarter for Hep C?

Shawn Guertin

I don’t have the patient count. We spent about $30 million on Solvadi in Q1 again with the majority of that being in commercial and Medicare.

Peter Costa – Wells Fargo

Thank you.

Operator

And we’ll go to our next question from Scott Fidel of Deutsche Bank.

Scott Fidel – Deutsche Bank

Thanks. Can you just give us an update on what you’re seeing in the commercial pricing environment at this point and maybe focus a bit on New York, just given some of the comments that United had made. And then just also we’d be interested, Mark in your thoughts on the 2015 exchange premiums, just the CBL having come out recently with a view that exchange premiums across the industry will only be up around 3% which seems to vary quite significantly from what we’re hearing from companies. So we just wanted your thoughts around that, too.

Mark Bertolini

Sure. I think the pricing environment remains rational. I think we would say if there was any irrational pricing it happened with a few of the co-ops as they went into the exchange. We in those markets actually withdrew from those markets as we were asked to meet co-op rating. And so I think our view was where was saw irrational players it wasn’t appropriate for us to participate.

I think other than that I think we have a very rational marketplace as we always do. Our pricing did consider the shift between ACA-compliant plans and early renewals. And so I think for us we believe the pricing environment is a good environment now, and I think again as I’ve said before minimum [MORs] create sort of an inability for you to scrape back losses if you go out and buy business. So it’ll be interesting to see in some of these cases how people look at their rate increases in the future.

As it relates to 2015 I would say, and I’ve seen the first review of our pricing as we get closer to May and I’ve sat with the team actually this week, we have 132 rating areas that we are applying across 17 states. And so as you know all of those need to be approved individually and I would say the range of our rates are very low single digits to some that will be over double digits, and in large part that depends on number one, the amount of membership we have in the market; number two, the demographics of that membership, but probably even more importantly the lack of clarity about what kind of experience we have.

In the individual market, we generally rate this business 60 days beforehand, and here we’re being asked to do it months, seven months beforehand. And as a result our conservatism goes up. As a result of looking at “keep what you have” and other changes that have been made on the fly to this program we would say that that adds at least half of the rate increase in most markets where we’re applying those rates.

And so all of this in the rating models creates conservatism and creates pressure, but again, our range is low single digits, very low single digits to over double digits and we’ll have to go market-by-market as we move ahead.

Scott Fidel – Deutsche Bank

Thanks. And just to clarify, just the comments on seeing a very rational market in commercial – that would be inclusive of the New York market as well?

Mark Bertolini

Yes, I mean the New York dynamic is actually interesting compared to the rest of the country. New York is unique with a couple of other states where they were guaranteed issuing community rated to begin with. So the effect of ACA rates on that marketplace was a lot smaller than most other marketplaces where we had to factor in all the ACA changes. And so for us prior to this change we were sort of on the edges of the market, fairly highly priced because we didn’t like the guaranteed issue nature of the marketplace.

Given that we had to get our head around how to do that across the individual market and some small group markets across the country in the shop exchanges we now have a model where we can work with that. The impact on rates was a lot smaller than most other markets.

Shawn Guertin

Yes, and Scott, I would tell you that in Q1 our small group ratio nationwide was fine, it was right on expectations; and our small group loss ratio in New York was fine. So I think that that speaks to Mark’s points.

Scott Fidel – Deutsche Bank

Okay, thanks.

Operator

And we’ll go to our next question from Christine Arnold with Cowen.

Christine Arnold – Cowen and Company

Can you please speak to where Coventry’s synergies and accretion are coming in relative to your initial guidance of about $200 million?

Mark Bertolini

Christine, Coventry continues to perform very well for us, and as I mentioned it is one of those areas that we continue to work at because I think it is an area where we could have the potential to overachieve this year on the synergy and accretion side. And like I mentioned on past calls we are definitely trying to do that. At this point, though, I wouldn’t go there quite yet in the year and so we’re standing by our original estimates for this year of $200 million in synergies and $0.50 of accumulated accretion.

Christine Arnold – Cowen and Company

Okay, thank you.

Operator

And we’ll move on to our next question from Ralph Giacobbe of Credit Suisse.

Ralph Giacobbe – Credit Suisse

Thanks, good morning. Do you have any better clarity or understanding of sort of the three Rs at this point – how those protections may sort of impact 2014 and at this point how that will sort of influence the 2015 bids?

Mark Bertolini

So I think one of the important things to think about here, Ralph, in the overhang of all of this is that the government has said it’s going to be budget neutral which means that there have to be plans that make a lot of money in order to subsidize plans who don’t. And given where the changes have been and a whole lot of other noise we don’t know whether there’s going to be a whole lot of money coming into the program to send to companies who lost money. And so our view is pretty… We don’t expect a whole lot out of the three Rs coming from the 2014 plan year.

Shawn Guertin

And just specifically, Ralph, in Q1 we did not book anything for the risk corridor or risk adjustment, and we have a very modest reinsurance recoverable which is based only on known claims at this point.

Ralph Giacobbe – Credit Suisse

Okay. And how does that influence I guess the 2015 bids?

Mark Bertolini

Again, changes to the program that we have seen on the fly here have added we believe half the rate increase to most of our rates across the 132 rating areas.

Ralph Giacobbe – Credit Suisse

Okay, thank you.

Operator

And our next question comes from Ana Gupte at Leerink Partners.

Ana Gupte – Leerink Partners

Yeah, thanks, good morning. I just wanted to follow up on your membership commentary. I think you said you had 230,000 paid members from public exchanges if I understood this right – 100K came into your off-exchange individual but that was offset by 100K loss in limited benefits? And then overall your commercial insured is flat, so is the implication of that then you had a 230K-ish loss from your group membership? And if so where did they go? Did they migrate to exchanges or did they migrate as a group to other plans? In other words did you get uninsured in your exchanges or not?

Mark Bertolini

The simplest way to think about what has happened with the commercial insured membership is that the individual membership grew by 100,000 members. 230,000 of those were on-exchange members, so we lost 130,000 off-exchange members but that’s net plus 100,000. That was offset by the loss of about 100,000 members on the limited benefit products which are going away as a result of the ACA, so overall membership was flat. The implication of that is that our sort of core group membership if you will was more or less flat over the quarter.

Ana Gupte – Leerink Partners

Got it, okay. And so that means that you actually lost members in off-exchange.

Mark Bertolini

Yes.

Ana Gupte – Leerink Partners

It seems like the [Blues] and some others are reporting a lot of growth in off-exchange.

Mark Bertolini

Yes, we lost 130,000 off-exchange members in the quarter.

Ana Gupte – Leerink Partners

Okay, thank you.

Operator

And we’ll go on to our next question from AJ Rice of UBS.

AJ Rice – UBS

Obviously a lot of questions have been asked and answered here but I think I might just ask you to comment for a minute on the international side. Obviously you have highlighted it – you just announced yesterday that you closed on InterGlobal. Where are investments in international at this point in your thinking and maybe just any update on your strategy regarding international?

Mark Bertolini

Sure, AJ. What we’re doing is private medical insurance in certain markets, so InterGlobal gives us a greater presence in Europe and some parts of Africa. So we’re looking for footprints where we can gain access to members in those markets for private medical insurance. The bigger opportunity in our mind is in population health management where we are able to influence the construction and structure of healthcare delivery in markets. And so for example, in Qatar we are now managing their national health system providing fees management and information about how to address demographic and disease burden issues in their population.

We see more of that as an opportunity to build a solid base and foundation upon which we can then begin to offer affordable insurance to the emerging middle classes in those nations. So we’re continuing our expat business, we’re looking for more private medical insurance opportunities in local markets and footprints where we can do that. And then third, I think the longer term investment that will take some time but affords us opportunity to go after the emerging middle class in these nations where the middle class is growing the fastest in the world by helping to create the infrastructure necessary for an affordable healthcare system.

AJ Rice – UBS

Okay, thanks a lot.

Operator

And we’ll go on to our next question from Matthew Borsch of Goldman Sachs.

Matthew Borsch – Goldman Sachs

Yes, thank you. I was hoping you might just talk about the member composition on the ACA exchanges. And sorry if I missed something here but as you look at those 230,000 do you have a sense for or any tabulation for how many were previously Aetna members? Or I guess that’s a net add so maybe the answer is zero, but where they came from in terms of being previously insured or uninsured?

Mark Bertolini

Well, let me give you some broad statistics and then I’ll have Shawn get into some of the details. But I think first of all 230,000 in Q1, since then we have over 600,000 that have enrolled but less than 500,000 that have actually paid. And so our view of this is that we’re not quite sure how this last cohort of individuals that came into the program, whether or not they will actually pay it or whether or not they were somehow encouraged to enroll. And so we’re waiting for that to clear, but generally we see about 80% of the people who enroll actually pay.

Shawn Guertin

Yeah, Matt, about 20% plus or minus appear to have been previous customers of ours. We really don’t have a good statistic on whether the balance of those people were insured or uninsured.

Matthew Borsch – Goldman Sachs

And sorry, just related to that can you comment on the Medicaid expansion and your view of robust you think that is across your markets?

Shawn Guertin

Yeah, we had about 50,000 members added in Q1 as a result of Medicaid expansion and as we look to the balance of the year we’re expecting roughly another 50,000 more for a total of about 100,000.

Matthew Borsch – Goldman Sachs

Okay, thank you.

Operator

And next we’ll hear from Kevin Fischbeck of Bank of America.

Kevin Fischbeck – Bank of America Merrill Lynch

Great, thanks. I think last quarter you kind of provided a view about where you guys might be going from an earnings perspective over the next three years, talking about the headwinds for 2014 and then lessening to some degree in’15, and getting back to normal growth in 2016. I just wanted to see if, as you get more color about what’s actually happening in ’14, what the MA rates are for ’15, how do you think about that? Has anything really changed in your view?

Mark Bertolini

Well, I think a couple of things. Number one on the Medicare funding gap solve it’ll be high single digits for both years, ’14 and ’15, which by implication means it’s very low single digits for us for 2015 – the advantage of the Medicare STARS ratings in some of our geographies where we actually enroll members. And so for us getting in where we are in Q1, the opportunity to get way in front of that by making investments now for 2015 and making investments in STARS is a very important part of what we’re doing in giving you the kind of guidance range that we’ve given you already, is to start those investments now.

So we’re trying to bolster the ’15 commitment that we made, that ’15 looks better and then ’16 better than that, but over time, 10% plus on average over time for our EPS growth.

Kevin Fischbeck – Bank of America Merrill Lynch

Okay, and then I just want to understand how you guys end up thinking about Solvadi, if it does end up being an issue this year. Is that just a one-time issue? Is that something that you would expect to fully recapture in the 2015 rates or do you expect that either this becomes something that becomes a permanent headwind or it takes longer than next year to fully recapture that?

Mark Bertolini

Yeah, I think that remains to be seen. I mean obviously it would be our intent to capture this as best we can in pricing, and the uncertainty around this issue really is the degree of ramp and the pace at which this keeps ramping up and if and when it starts to stabilize. And I think those would be the factors. As with anything new in terms of how quickly you get it into pricing is how good a job you do projecting the ramp up and then sort of the ultimate stabilization point, and it’s just awful early in the lifecycle of this to know with any specificity whether we would do that. But clearly that would be our intent.

Kevin Fischbeck – Bank of America Merrill Lynch

Okay, great. Thanks.

Operator

And we’ll go next to Chris Rigg of Susquehanna Financial Group.

Chris Rigg – Susquehanna Financial Group

Good morning, thanks for taking my question. I guess when I think about your public exchange enrollment and what you’re expecting over the latter three quarters of the year, it seems like it’s been pretty successful. But at the same time if I heard you correctly you kind of want to keep your footprint relatively unchanged for 2015. Can you help me sort of think through that? Is it just you want sort of two years’ of experience under your belt before you expand markets? Or just any color about how you think about that business going forward, thanks.

Mark Bertolini

I think it’s literally that we just don’t know what we have and we don’t know how profitable we’ll be or what we’ll need to do to be profitable in those markets. So we think given how little we know, and more importantly, this program keeps changing every month. Until it somewhat stabilizes and we know what kinds of investments we need to make we just want to play the cards. We’re a large participant; we want to be playing the cards we’re dealt right now.

Shawn Guertin

Yeah, Chris, and if you think about our strategy, it was looking at this as optionality. And getting in and getting enough meaningful experience to sort of know how to take advantage of this down the road – we’ve accomplished that this first year. And I think prudence dictates that we don’t necessarily need to dramatically expand that any further when you think through that strategy.

Chris Rigg – Susquehanna Financial Group

Understood, thanks a lot.

Operator

And our next question comes from Sarah James of Wedbush.

Sarah James – Wedbush Morgan Securities

Thank you. I wanted to talk about your multiyear Medicare strategy for a moment. You mentioned planning some exits in ’15 but several of your peers have talked about the Medicare environment improving in ’16; and given the stickiness of Medicare members it seems unlikely you’d exit a market in ’15 just to reenter in ’16. So I’m wondering if this suggests that you see continued rate pressure in ’16 and beyond and how we should think about the scale of the ’15 exits versus the ’15 exits, thanks.

Mark Bertolini

I think, Sarah, that the market exits are a last resort for us. So the very first thing we look at are network contracts and medical management, what can we do to bolster that, overlaid by STARS. And then we start looking at benefits, and to the degree we hit benefit limits we’re not able to make the changes, or we’re not large enough in a market to get the cost structure right then pulling out of a market is a last resort. So I always view that as our darkest day when we have to pull out of a market because of the opportunity that we think we have in the program.

Shawn Guertin

And Sarah, I would view that as more of a directional comment. Market exits were not a big part of our ’14 strategy but as we mentioned, when the plan gets cut again at less than trend that just puts pressure on everything that you need to do, including the potential for market exits. But it would not, as Mark said it is not sort of the first choice – it is the last choice.

Mark Bertolini

And then on funding I think politically the question is what happens next year? I mean this year is an election year and were there considerations made for that? There’s going to be a change in the administration at CMS in a number of different ways and HHS, and so what is the tell? We don’t know yet but we do know that we have a better dialog now as an industry, that the business is now 16 million members, Medicare Advantage members – 30% of the Medicare marketplace; that the people who are retiring, 11,000 a day, are people who like these kinds of programs.

So I don’t think anybody’s going to destroy the program. I think the dialog has been a constructive one and we hope that continues.

Sarah James – Wedbush Morgan Securities

Thank you.

Operator

And we’ll hear next from Dave Windley of Jefferies.

Dave Windley – Jefferies & Co.

Thanks. Curious about your conversations with your national account, large group-type commercial clients especially as it relates to motivations to move to private exchange. I’m wondering if you expect that to accelerate as we move toward 2015 and if you also expect that the distribution between [ASC] and full risk selection as a movement to private exchange will match this two-thirds that you’ve seen this year.

Mark Bertolini

Yeah, I think on the first one there is definitely a lot more interest and we’re having a lot more conversations, and a lot more people are talking about private exchanges. I think as the renewals come in for the second year, those already in the exchanges, that’s going to be sort of a marker as to whether or not the current structure of the private exchange marketplace works.

We have a number of proprietary private exchange opportunities we’re pursuing as a next evolution of the private exchange model, and we think that’s going to have more economics associated with it. So we think this trend will continue and we hope that if we can prove that we’re able to manage trend more effectively over time, that employers will consider moving to defined contribution sooner – and as a result we’ll create more of an opportunity in the insured marketplace. But that all is you know, stuff that we’re going to have to manage as we move ahead.

Dave Windley – Jefferies & Co.

The proprietary approaches that you allude to I presume are what you call the Aetna Marketplace – is that correct?

Mark Bertolini

Right, and the Aetna Marketplace can take any number of versions. Number one, it can be around an industry vertical where we have strong industry strength, and for us in the national accounts space that’s in the healthcare business, that’s in gas & oil and energy, and that’s in retail and hospitality. So those are opportunities to build exchanges around groups of employee populations that have similar risks and similar needs, and to build not only the buying experience but also the care management and network models necessary to effectively address those populations.

The other models that we’re experimenting with and are launching here very soon are private exchanges bolted onto the front of our ACO models where those provider systems in those communities can be able to sign up individual and small group and participate in what we’ll create as a national ACO chain where we have private exchanges on the front of ACOs that can address large employer populations in specific markets – potentially disrupting the national account business by making their purchases more local.

Dave Windley – Jefferies & Co.

Interesting, thank you very much.

Mark Bertolini

You’re welcome.

Operator

And we’ll go to our next question from Michael Baker of Raymond James.

Michael Baker – Raymond James

Yeah, thanks a lot. Mark, just to follow up on that last question, can you give us a sense of what you’re seeing in terms of in-market employers given the fact that some of the consulting shops that target them have come up with their own exchange solutions? And then I just have another question after that.

Mark Bertolini

Yeah, not a lot right now. I know there’s a lot of interest but quite frankly for those businesses it’s not time to think about this yet. So the national account business is early because this is the cycle, but the middle market businesses are going to be later in the year. So we haven’t seen a lot of activity, a lot of talk but not a lot of activity.

Michael Baker – Raymond James

Okay, and then just on the specialty pharmacy management side, obviously you have a partner there. I’m just trying to get a sense for if you’re starting to do things that are unique in the marketplace, whether through your contracted relationships with providers or other types of means that would more meaningfully bend trend there, especially on the pharmacy management side of the house so to speak.

Mark Bertolini

Our CVS relationship is going well. We’re finalizing our transition as we’re migrating our business over. We’re going to migrate the Coventry business, so migration when the other contract expires. But we’ve been focused on making sure the migrations happen effectively. What we’re seeing is that our penetration into national accounts is actually coming back up so we’re having some good successes there, so those are sort of first order issues in that relationship.

Other issues around how do we think about these drugs, we’re now beginning that process in strategy development and how we can work more closely together; fraud and abuse, specialty pharmacy, mail order both at the store and at home.

Michael Baker – Raymond James

I appreciate the update, thanks.

Operator

And our last question comes from Tom Carroll of Stifel.

Tom Carroll – Stifel Nicolaus

Hey, good morning. I wonder if you might give us an update on the two dual programs that Aetna was awarded this year, and also maybe make some comment as to if you’re tracking any attractive emerging markets or state programs that you see on the radar screen. Thanks.

Shawn Guertin

Yeah, Tom, we do have some clarity now on Ohio and Illinois in terms of timing. We can get you, I have the specific dates, but really the voluntary enrollment will largely be starting sort of at the end of Q1 and in Q2, and then the passive enrollment – which is where we would get more of the membership presumably – is going to be starting I think on 6/1 in both the markets, or 6/1 and 7/1 actually in both of the markets. So the easiest way to think about it is we’ll get some voluntary enrollment this quarter and then we’ll see the passive enrollment largely in Q3.

Tom Carroll – Stifel Nicolaus

Do you have any estimated rate amounts you’re going to be getting that you can give to us?

Shawn Guertin

Our updated guidance probably has $500 million of revenue attributable to this dual enrollment.

Tom Carroll – Stifel Nicolaus

Great. Let me sneak one more in if I could: can you just give us a sense of how Aetna is managing or assisting in managing the Solvadi ramp for the rest of the year, something to the tune of are you stratifying different membership, different enrollees into high risk and low risk and also looking at pricing discounts and things like that? Maybe just chat a little more in detail if you could.

Mark Bertolini

As a general rule right now it is on prior off, and so our clinical folks will review the appropriate clinical guidelines and make decisions on that basis. And I know there’s a lot of, this is sort of number one, right, on the list right now and there’s a lot of active discussion about sort of clinical protocols and how we should be employing those down the road. But right now the simple answer is we are following the existing clinical protocols.

We will obviously look at an array of strategies to manage the cost side of this equation but it is important to keep in mind that our ultimate decision on this is going to be a clinical decision by our folks.

Shawn Guertin

Also there are new drugs coming in for next year without the Interferon so there may be some queuing in the later part of the year that could slow some of this down.

Tom Kelly

Great, thanks Tom. A transcript of the prepared portion of this call will be posted shortly on the Investor Information section of www.aetna.com where you can also find a copy of our updated guidance summary containing details of our guidance metrics, including those that were unchanged and not discussed on this call.

If you have any questions about matters discussed this morning please feel free to call me or one of my colleagues in the Investor Relations Office. Thank you for joining us this morning.

Operator

And again, that does conclude today’s call. We’d like to thank everyone for their participation today.

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