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Humana (NYSE:HUM)

Q3 2010 Earnings Call

November 01, 2010 9:00 am ET

Executives

James Bloem - Chief Financial Officer, Senior Vice President and Treasurer

Michael McCallister - Chairman, Chief Executive Officer, President and Member of Executive Committee

James Murray - Chief Operating Officer

Regina Nethery - Vice President Investor Relations

Analysts

Ana Gupte - Bernstein Research

Christian Rigg - Susquehanna Financial Group, LLLP

Joshua Raskin - Barclays Capital

Justin Lake - UBS Investment Bank

Sarah James - Wedbush Securities Inc.

Peter Costa - FTN Midwest Securities

Carl McDonald - Citigroup Inc

Scott Fidel - Deutsche Bank AG

Charles Boorady - Crédit Suisse AG

Matthew Borsch - Goldman Sachs Group Inc.

David Windley - Jefferies & Company, Inc.

Thomas Carroll - Stifel, Nicolaus & Co., Inc.

John Rex - JP Morgan Chase & Co

Doug Simpson - Morgan Stanley

Christine Arnold - Cowen and Company, LLC

Kevin Fischbeck - BofA Merrill Lynch

Operator

Good morning. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the Humana Third Quarter 2010 Earnings Release Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Regina Nethery, Vice President of Investor Relations. Please go ahead.

Regina Nethery

Good morning, and thank you for joining us. In a moment, Mike McCallister, Humana's Chairman of the Board and Chief Executive Officer; and Jim Bloem, Senior Vice President and Chief Financial Officer, will briefly discuss highlights from our third quarter 2010 results, as well as comment on our earnings outlook for 2010. Following these prepared remarks, we will open up the lines for a question-and-answer session with industry analysts. Joining Mike and Jim for the Q&A session will be Jim Murray, our Chief Operating Officer; and Chris Todoroff, Senior Vice President and General Counsel. We encourage the investing public and media to listen in to both management's prepared remarks and the related Q&A with analysts.

This call is being recorded for replay purposes. That replay will be available on the investor relations page of Humana's website, humana.com, later today. This call is also being simulcast via the Internet along with a virtual slide presentation. For those of you who have company firewall issues and cannot access the live presentation, an Adobe version of the slides has been posted to the Investor Relations section of Humana's website.

Before we begin our discussion, I need to cover a few other items. First, our cautionary statement. Certain of the matters discussed in this conference call are forward looking and involve a number of risks and uncertainties. Actual results could differ materially. Investors are advised to read the detailed risk factors discussed in this morning's press release, as well as in our filings with the Securities and Exchange Commission. Today's press release and other historical financial news releases are available on our investor relations website. All of our SEC filings are also available via the investor relations page of Humana's website, as well as on the SEC's website. Finally, any references to earnings per share or EPS made during this morning's call refer to diluted earnings per common share. With that, I'll turn the call over to Mike McCallister.

Michael McCallister

Good morning, everyone, and thank you for joining us. Today, Humana announced third quarter earnings of $2.32 per share, which compares to $1.78 per share in the year ago quarter. This favorable result was achieved because of strong operating performance in both our Government and Commercial segments. We have updated our 2010 earnings per share guidance range to $6.40 to $6.50 compared to our previous forecast of $5.65 to $5.75 based on this operating performance and on the anticipated extension of our TRICARE contract. Jim Bloem will discuss this TRICARE development in the course of his remarks.

My comments this morning will be brief due to our upcoming Investor Day on November 18 where I'll be joined by key Humana leaders for in-depth discussions of our operations and outlook. We will also disclose 2011 guidance at that time. Today I'll spend just a few minutes highlighting our strategy and how our operating progress is positioning us for the long-term success before turning the call over to Jim.

I'll start with Medicare. Our long-standing focus on Medicare as a one-to-one Retail business combined with our emphasis on disciplined and innovative approaches to managing trend and coordinating care has served us well and is proving to be well-suited for the post reform world. Humana's holistic approach to our members is the linchpin of our ongoing 15 percent Solution. The results of which were evident in our third quarter operating results. The 15 percent Solution involves providing better benefits to our Medicare Advantage members that had cost 15% less than the cost of baseline benefits under traditional Medicare with higher quality and better outcomes than original Medicare. Delivering on this solution requires integrating many different functions on a large-scale, starting with building efficient provider networks and then coordinating targeted clinical interventions to address high cost situations that can be managed more efficiently to produce lower cost and better results.

This is becoming increasingly important in Medicare Advantage as payment rates continue to move toward parity with traditional Medicare. One important message of how this approach has positioned us well in relation to our competitors became apparent when industry-wide 2011 Medicare member premiums were announced at the end of September. Despite the economic challenge of Medicare Advantage payment rates being held flat with 2010, the success of our 15 percent Solution meant that Humana's 2011 member premiums for both Medicare Advantage and our existing PDP business went up only modestly.

Separately, our innovative co-branded PDP offering with Wal-Mart has for the first time since the PDP program was launched in 2006, won price and won benefit structure nationwide. This makes it easy to understand the key element for retail consumers. Further, it has the lowest premium of any PDP plant in all 50 states and Washington DC. This advantage coupled with the linkage of two leading brands with high favorability among seniors, we believe, is generating meaningful, positive awareness of the new product. That's been helped by comprehensive marketing campaigns from both companies prior to the opening of the annual election period on November 15. Together, we're introducing a positive disruption in the standalone PDP market this year.

The 2011 Medicare Advantage competitive environment reflects its own style of disruption. To be more specific, between competitor market exits, some Private Fee-for-Service market agents of our own, the introduction of network-based products to many of our existing Private Fee-for-Service members and the selling season that's been shorted by 90 days makes estimating net membership growth a bit more complicated than in prior years. Having said that, our preliminary estimates indicate we will still grow next year with our Individual Medicare Advantage membership likely increasing somewhere in the range of net for 2010.

Now I'll turn to our Commercial segment. Our Commercial strategy involves using the retail strengths we've honed in Medicare to capture opportunities in the individual market once the volatility from reform settles down. In the near term, we expect a very challenging transition period. We'll keep a close eye on the evolution of exchanges and other reform-related developments while forecasting minimum net membership growth.

Longer term, if the individual market expands, McKinsey estimates it'll grow from $23 million to $40 million in the next six years because of reform. We believe we'll be well-positioned. We anticipate offering not just individual health insurance or traditional ancillaries like dental vision and voluntary, but also new products related to consumers overall well being. Our goal is to create lifetime relationships with our individual customers, offering a variety of products and services based on incentives, rewards and loyalty. At the same time, we'll manage for profitability, our Group Medical business and expand our Specialty business in sections of the country where we have the scale and network position necessary to compete and win.

We will meet with you at our Investor day on November 18th. We look forward to sharing more details as to where we believe we're well-positioned in the near-term for our Medicare Advantage and PDP businesses and longer-term for our Commercial business. The number of consumer-oriented programs launched are underdevelopment and with the success of our one-to-one retail approach to membership growth, solidly aligned with the continued expansion of Medicare, and potential retail opportunities in the individual market, Humana faces the post reform future with confidence. With that, I'll turn the call over to Jim Bloem.

James Bloem

Thanks, Mike, and good morning, everyone. I'd like to begin by detailing the factors that contributed to our better-than-expected performance this quarter, as well as how they drove today's increase in our full year 2010 earnings per share guidance. As indicated on this first slide, there were four items that boosted this quarter's earnings per share, the last three of which pertain to our 2010 operations. With respect to the non-2010 item, we experienced an additional $56 million or $0.21 per share of higher than expected favorable medical claims development from prior years during the quarter. This amount is in addition to the prior year favorable development experienced in the first half of this year, bringing the full year benefit of this better than expected favorable prior year medical claims development to approximately $194 million or $0.72 per share. The beneficial effect by segment of the $56 million of prior year development recorded in the third quarter was approximately $41 million in the Government segment and $15 million in the Commercial segment.

Moving on to the three 2010 operating items, first, we experienced approximately $28 million or $0.10 per share of greater than anticipated favorable development related to the medical cost estimates recorded in the first half of this year with approximately 80% of that amount attributable to the Government segment and 20% to the Commercial segment. Much of this favorable development continued to be due to both a lower level of healthcare services utilization and a lower severity level of services performed. For our Medicare business, this lower than expected utilization continues to be driven by the continued effectiveness of our 15 percent Solution and the group accounts we gained at the beginning of this year. For our Commercial segment, the utilization declines are across all Medicare lines of business.

Second, in addition to the beneficial effects of lower utilization, we also continue to benefit from both pricing discipline as evidenced by our premium per member per month members and our administrative cost-reduction initiatives, which are on track to achieve our goal of $100 million in savings this year with a $200 million savings run rate for 2011. While our fourth quarter projections include the benefit of these cost reduction initiatives, we are more than offset by the shorter Medicare selling season, which this year, comprises all of our marketing expenses into the fourth quarter.

Finally, as we disclosed in early October, Humana Military Healthcare Services was notified by the TRICARE Management Activity or TMA that it intends to negotiate with HMHS for a one-year extension of our administration of the TRICARE program in TMA South Region. While the extension is still subject to negotiation we no longer plan to record a right off of TRICARE good will in the fourth quarter. That, together with timing issues that resulted in a $0.06 per share acceleration of TRICARE earnings from the fourth quarter into the third quarter, increased our full year 2010 TRICARE earnings expectations by about $0.25 per share.

Returning for a moment to Commercial Medical costs trends, we've reduced our estimated 2010 full year secular trend to a range of 4% to 5% in order to give effect to the unusually low levels of medical services utilization that we, as well as the entire industry, are experiencing this year. We continued to see low utilization levels for almost all medical services versus historical levels. Additionally, as mentioned above, the mix of services we are experiencing continued to be less severe than in recent years. Accordingly, we've raised our 2010 Commercial pretax outlook by $105 million today.

So looking at the full year 2010, we are experiencing a Commercial cost trend that's roughly 3% lower than we anticipated at the beginning of the year, which in turn, has been reflected in the increased pretax earnings guidance we've issued as we've progressed through this year. Although we're not issuing 2011 guidance until Investor Day, we would expect that medical cost trends in the Commercial segments will revert closer to historical levels and we've priced accordingly.

Turning last to operating cash flows and capital deployment. We've continued to generate strong operating cash flows during the third quarter, with $1,210,000,000 versus $940 million in the third quarter of 2009. This brought our 2010 year-to-date total operating cash flows to $2,290,000,000 versus $1,150,000,000 in the same period a year ago. The year-to-date cash flows from operations improved in tandem with our operating results, as well as the corresponding favorable changes in working capital items, particularly medical claims payable, as well as expense accruals.

Given the increased fourth quarter administrative expense spending that I referenced a minute ago, together with our annual fourth quarter cash settlements with CMS, we don't expect an increase in our operating cash flows for the remainder of the year. Consequently, our 2010 full year operating cash flows are now expected to be in the range of $2.1 billion to $2.3 billion versus $1.4 billion in 2009. As always, we continue to evaluate bearing opportunities to ensure shareholders receive the benefit of our increasing parent cash balance.

And we are pleased to repurchase an additional $50 million of our shares this quarter. This brings our year-to-date share repurchases to $100 million for just under 2 million shares. Our capital deployment efforts remain focused on effectiveness building capital expenditures, potential acquisitions and strategic investments, as well as continuing to repurchase our shares. Having and conserving ample capital liquidity provide us the financial flexibility that we need in order to compete effectively in the new environment as it continues to unfold.

So to conclude, we are pleased with both our financial results and our operational progress during the third quarter. We are confident that our updated 2010 earnings guidance range of $6.40 to $6.50 per share reflects our organizational experience and competency, as well as our continued discipline and intentional approach to the current and coming operating environment. With that, we'll open the phone lines for questions. We request that each caller ask only two questions in fairness to those still waiting in the queue.

Operator, please introduce the first caller.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Josh Raskin from Barclays.

Joshua Raskin - Barclays Capital

I have a question just a little bit about the PDP strategy for 2011, particularly in light of the repositioning that we saw for 2010 and I know you've said in the past that not every product in every region has to be a 5% target for it, for a part of that overall goal. So maybe you could help us with the Wal-Mart product, the national product. What are some of the key factors that you guys put in when coming up with that pricing? Maybe talk a little about administrative leverage or ability to convert MA long term? Or how should we sort of think about that product?

James Murray

This is Jim Murray. If you think about our average premium for our existing PDP membership, it's around $40 and the Wal-Mart premium, as you all know, is about $15. The factors that we evaluate with our actuaries and with the folks from Wal-Mart included us being willing to take a reduced profit from our existing PDP membership. We got better rates from Wal-Mart as you might expect than our base in our regular PDP membership. We're assuming that we'll have a much increased generic dispensing rate from our existing block of business. There is some amount of risk sharing that Wal-Mart was willing to take with us, that baked into that. Some of those favorable things are offset by our anticipation that our rebates would drop because of the increase in the generic drugs that people will take. And if you think about our existing block of business, there's a certain amount of risk element in that and although we are anticipating a slightly better risk profile and so there were some beneficial effect of that. When you put all those factors together, we were able to get to the $15 national premium, which we're very pleased about that as we work with Wal-Mart, they were very desirous of having one national premium and we felt very comfortable that we could do that. And as I think Mike has shared with many of you as he's gone around to the various investor meetings, what we think is that having a relationship with the senior population is going to benefit us long term. Additional products and services can be used in that existing membership base, the $15 thus produce a nice profit for us going forward and we just think it's an opportunity to grow our relationship with a significant number of seniors this year.

Joshua Raskin - Barclays Capital

Okay, so you said maybe a lower profit percentage, but still a nice profit for you guys?

James Murray

That is correct.

Joshua Raskin - Barclays Capital

Second question, the 15 percent Solution and continue to see the progress there, there's a lot of different phases and timings depending on county and membership, could you help us understand when do you feel like you really need to be there? When do you need to be at that full 15 percent Solution for your membership based on the reimbursement transition that we're going to see over the next, call it six years or so?

James Murray

This is Jimmy Murray again. As you all hear, when you're all here in November, we're very pleased with the progress that we're making on the 15 percent Solution. We monitor that regularly. It was helpful for us, as Mike said, in his remarks, to be able to produce premiums and benefit levels this year, which we think will favorably impact the persistency that we've experienced with our M&A block this past year. As we look forward, we anticipate that by 2014, we could be in really good shape as respect to the 15 percent Solution. And so for us, it's a journey. We expect improvement each and every year, which will help us to keep our premiums low until 2014 and we would hope that by 2014, the 15% or more solution is in place in a lot of the places that we do business. We're very pleased with the progress we're making.

Michael McCallister

Josh, this concept of managing care and organizing care has been around for a long time and I've been saying for the last year and a half, that I'm really becoming comfortable that we're starting to see traction as we integrate all this because it is a different approach than historically what we have bore out of the Managed Care world. We are dealing with better data sets, better customer relationship management capabilities. We've learned a lot with the work we've done with the most fragile folks we take care of. It's just been interesting now we're beginning to connect better information flows, better data, very focused ROI approach to deciding where we're good to spend our money and where we're going to work. It looks pretty good in terms of being able to squeeze out what I've been talking about forever, which is a huge amount of waste and nonsense in the Medicare program.

Joshua Raskin - Barclays Capital

Could you give us an update on your bonus for your stars for NCMS?

James Murray

Yes, we've got the scores on about 42 Humana plans. We're not doing, as well as we would like. We look at the process and the methodology. We're working with the Government to try to create something that we think would be a better measure of quality, and we think there should be more waiting towards clinical evaluations as opposed to some of the other measures that are currently a part of the process. Now that it's a part of our payment methodology, rest assured that Humana will become very good at quality. But again, we would really like to have a discussion with folks in Washington about a better approach towards quality and what quality can ultimately become for the seniors that we serve.

Operator

Your next question comes from the line of Matt Borsch from Goldman Sachs.

Matthew Borsch - Goldman Sachs Group Inc.

Maybe I could ask couple of questions on the Commercial side of the business. I'm curious what you're seeing in terms of the trend on your individual non-employer book going into next year. And the extent to which HHS granting some leeway for states to phase in the MLR rules is critical on that product from your perspective.

Michael McCallister

I'll start. Well, we don't -- barring some changes in terms of the implementation of the MLRs, next year is not going to be a good year for the R [ph] Individual book of business we've separate forward. We're fortunate that it's slightly bigger than it is. But the 80% just doesn't work in the short-term and the administration knows that, we know that and the insurance commissioners know that across the country. So that's why you're seeing so much noise around people trying to think about exceptions to that, deferral of it, delay of it, transition of it. It is very disruptive to the individual market and while it's something that we're not happy with in terms of the impact that Humana, it's not a huge impact to us. And I think at the end of the day, as we get for the rest of it, they're going to realize that this is going at a minimum need to be transitioned, if not, put off completely. But news on 11 on that.

Matthew Borsch - Goldman Sachs Group Inc.

And maybe more on the group side of the business, are you seeing a pickup in interest in self funding, I know it's been out there, but is that -- has that increased at the higher end of your, maybe in the middle market and certainly in the large group?

James Murray

As you know, the self funding has escaped the boundaries of healthcare reform. There's no minimum MERs for self funding, there's no exchanges and there's no premium tax. So we look to self funding as an opportunity for us and we're looking at ways to think about whether we want to go to smaller case sizes on a self-funded kind of a basis. But frankly, we're not seeing any strong movement towards self funding in the last several months, but they're always looking to see whether we're seeing changes in the way that companies buy our products but haven't seen anything of that of late.

Michael McCallister

Clearly, that health reform will push people in that direction over time.

Operator

Your next question comes from the line of Justin Lake from UBS.

Justin Lake - UBS Investment Bank

Just the first question on Medicare Advantage membership, I think you mentioned that you expect the individual membership to be similar to what you had this year. Can you break that down for us again? And also, any commentary of the corporate market for 2011?

James Murray

Sure. This is Jim Murray. We've gotten into some discussions and relationships with large, mostly Government accounts. We don't have any for January of this year. As I step back and try to figure out why that's the case, it appears like the governments that we do business with run in packs, if you will. The first group that we were able to sell for January of this past year, I would characterize as very progressive in terms of their thinking and solutions. And so we were very pleased that we were able to write so many this year. We're having conversations with others. I would suggest that there might be some opportunity to sell some larger cases during the course of 2011, not January, and perhaps more towards January of 2012. What we're trying to do is to demonstrate to these folks that we've seen great success with some of the large cases that we wrote in January of this year, we'll share some of that with you when you're here in November. As respect to our individual sales, there's lots of rhetoric about the number of Private Fee-for-Service exits, just the kind of -- summarize a lot of that, I would suggest that there's probably 700,000 Private Fee-for-Service members where their current carrier is changing. And of that, we're about 100,000 or so of those directionally, which leaves about 600,000 members that are held by our competitors. Of that 600,000, our competitors have products that would cover 250,000 of those individuals and so we'll see the success that our competitors might have on selling them from a Private Fee-for-Service to a network-based offering. So that's something that has to play itself out. Outside of our footprint is another 100,000, so that leaves about 250,000 folks that are in our footprint and don't have competitor offerings that we have to deal with. And so as the leader of the market point organization shared with me, we'll sell as many of those as we possibly can and so that's what we were really targeted on. Other things that are impacting this open enrollment period is the shorter selling season, so that negatively impacts us to some extent. Offsetting that is the stability of our premiums and benefits, and we're looking to see that our persistency improves because of that. So there are really a lot of variables that we're trying to evaluate when we give guidance and when you're here in November, we'll share a lot of that information with you. But at this point, we're comfortable saying we'll sell as many individual members next year as we did this past year.

Michael McCallister

I would add that in the large group Medicare space, I don't know that that's going to play out to be a January event every year. This is the type of business where they can change during the year and we've seen some of that in the past. So the timing might be a little bit different on it.

Justin Lake - UBS Investment Bank

One other question just on the Commercial business, without getting into specifics, it seems like there's, like you mentioned, some headwinds on the individual side. Can you kind of give us directionally how you think about Commercial operating profit next year? And maybe any offsets you might be able to put in place via commission changes?

Michael McCallister

Well, we will definitely be looking at commissions and we're looking at administrative costs and a lot of things we can do to soften the impact from all this and we're doing all of them. You want to add to that?

James Murray

The only thing I would add is that, this past year, we and others in our industry have enjoyed a very good utilization season. We're not anticipating that, that will recur next year because we want to be careful. So our pricing and visions but our trends will go back to normal levels and the windfall that we received this past year might not recurr. So that would be one of the things that I would put out there as you're trying to figure out our earnings from our Commercial block of business next year as something that will impact us. The other thing is the individual business, it's a good thing that it's only 2% of our total revenue. But the MER changing from where it's running today to 80% is a negative.

Operator

Your next question comes from the line of Chris Rigg from Susquehanna.

Christian Rigg - Susquehanna Financial Group, LLLP

Just a quick question, could you provide any color on any areas of specific utilization declines? And if possible, give us a sense of any differences you've seen in the Commercial versus the Government side of the business?

Michael McCallister

As I mentioned, in terms of the trend, you've seen basically, and as Jim has just mentioned, basically we've seen trends dropped 3%. Generally speaking, the most improvement we've seen is in the severity area, the rates continue to be, tends to be good competition and good pressure on the rates, but the severity that is of the services performed have been the larger component of the decline.

Christian Rigg - Susquehanna Financial Group, LLLP

And then just a quick follow-up on the G&A savings you're expecting for this year, I think you had talk about previously of $100 million and $200 million long-term. Can you give us an update as to where that savings plan stands at this point?

James Bloem

We're very pleased with the progress that we've made so far. We know that we have $100 million realized and we have the run rate of $200 million that we're working our way to get in terms of the run rate. We're very assured that we're going to see that for 2011. When we look at our overall spending, though, part of what we said with our administrative cost reductions is that they would be also accompanied by a sort of reconfiguring our competencies to get more in line with what the competitive realities are going to be and what the law was going to require. So when we look at it in an overall sense, you can't really see it on the income statement, although we're very pleased with third quarter results and year-to-date results. But when you look at our SG&A and ratio, that's where I think you can see the real impact of it, if you remove the debt write off that we made in the second quarter, you put 40 basis points off of what we're saying for the year of between 13.5 to 14 so that takes into the 13 in a quarter range and we think that's very good progress given what we've needed to invest in to become compliant and to become effectively competitive in light of the new environment.

Operator

Your next question comes from the line of Charles Boorady from Credit Suisse.

Charles Boorady - Crédit Suisse AG

I want to understand the expectations a little bit better for the narrowing of the marketing window. And to what extent does a shorter window really hurt you in the enrollment process? And any initial read you have on that and whether you've taken that in consideration in the preliminary outlook for 2011 enrollment that you shared at the beginning of the call?

James Murray

Sure. The narrowing of the window for selling is about, we think, 65,000 less sales that we would make. Offsetting that to some extent, however, is the fact that when you narrow the selling window, you also narrow the termination window. And so we think those are somewhat offsetting, but that in time will play that out for us.

Charles Boorady - Crédit Suisse AG

And when you pulled forward the expense, so you're going to be spending about the same amount of money in total? Or are we able to reduce the actual total annual spend as a result of the shorter window?

James Murray

When we pulled it forward, we have a couple of things that we've mentioned we're going to be spending in the fourth quarter. Last time we mentioned the $75 million or $0.28 a share, but we didn't describe it to Wal-Mart because we haven't announced Wal-Mart, but that's what it is. But then there's the non-Wal-Mart part, and again, because of the acceleration and because of wanting to make sure that we get ourselves into making expenditures that help us grow profitably, but also give us multiple years of savings and also reduce our medical costs, those are increasing our fourth quarter spending a lot. And again, coming back to your question then I think that, that does pull a lot of it into the fourth quarter in terms of what we're going to be looking at next year.

James Murray

I would agree with that. Just a little bit of color. From a short-term perspective, the shortening of the selling season impacts our career selling organization. But we're really excited with a lot of the focus that we got on other kinds of products throughout the course of the year. And I would suggest that over time, and this will be a journey, that as our selling organization creates relationships with folks around other kinds of products and services that Humana will offer on a retail basis, that the need to do the amount of marketing spend in the last part of the year will begin to diminish. And so that's kind of how we see this playing out. But short-term, as Jim said, it was probably the same amount as last year, plus a little bit more for Wal-Mart.

Charles Boorady - Crédit Suisse AG

So 2010, you have a double whammy because you spent at the beginning of this in the first quarter and now you're spending a full year's worth in the fourth quarter on an ongoing basis next year and beyond, will the total annual spend be about the same? Or more? Or less?

James Bloem

That's not determined until we actually sort of see where we sit from a competitive position. So we always have a number out here that we have in mind. But that moves every year, and we've been doing this for several years now based on what we learned relative to our competitive posture.

Operator

Your next question comes from the line of Scott Fidel from Deutsche Bank.

Scott Fidel - Deutsche Bank AG

First just a quick question on the MA sales relative to the 2010 guidance for the 250,000 to 260,000 adds, how would that break out between individual versus group sales?

James Bloem

The group sales for 2010 was about $198,000, so the rest is $730,000 in total, there's plan to plan changes of $150,000.

Scott Fidel - Deutsche Bank AG

Just you gave some good initial color just on sales expectations for MA in 2011 and can you maybe walk through the same exercises just around preliminary views on Commercial group enrollment for 2011?

James Murray

We'll do a lot of that in November, if that's all right with you?

Scott Fidel - Deutsche Bank AG

Just on the change in your guidance for in-patient and out-patient rates, you're now looking at low to mid-single digits which looks to be very favorable. How does that road break out between improvements, let's say, in the severity adjustments as compared to the base rates? Are you seeing base rates actually coming down to that level? Or is it really just that you're seeing a much more favorable dynamic around severity?

James Bloem

It's the second one, Scott, the severity is the main driver. There a lot of pressure on rates, but severity is what's driving the reduction in trend.

Scott Fidel - Deutsche Bank AG

Where would you qualify your base rates within at this point?

James Bloem

We think that the guidance we gave is pretty close on rates. But again, you saw that from last quarter, it's like that two knives dropped. So within that range, again, we still believe that severity is the most, but now that the utilization is down and the number of episodes is down, there's pressure on the rates, too.

Operator

Your next question comes from the line of Kevin Fischbeck from Bank of America.

Kevin Fischbeck - BofA Merrill Lynch

I guess I wasn't clear on this earnings guidance chart, but the Q4 guidance where you take $0.06 out of the x TRICARE earnings. What is that related to?

James Bloem

What we have had before was, we had said in the fourth quarter because of the contract, we were going to write off goodwill, we're not going to do that. In addition to that, we have some transition costs in there which were about $0.06 that went along with exiting the contract and that's stated there. And then one more, there's another $0.06 and that's the $0.06 that comes with the improvement in TRICARE's performance for their overall for the year. So again, TRICARE, that's why we basically said that we, looking at TRICARE for the year now, are saying $0.25 a share is the improvement from when we talk 90 days ago to today.

Christine Arnold - Cowen and Company, LLC

So even though the $0.06 write off was related to TRICARE goodwill, you called it improving operating performance x TRICARE?

James Bloem

It was basically, with the TRICARE write off team, additional cost to transition out of the contract because the goodwill write-off is a matter of matching up cash flows with the carrying value of goodwill. But then there were also was originally in there some transition costs. The improvement was basically a forwarding on the operating side of what we would probably have in the fourth quarter into the third quarter.

Kevin Fischbeck - BofA Merrill Lynch

And I then guess on the cash flow statement, the cash balance on the corporate year seems -- to me, it seems like it's burning a hole in your pocket. How do you think about deploying that cash? Is there a timeline for presenting about how much cash you need at corporate? How quickly you want to deploy the capital? And whether there's a situation where you say, hope there's some time line if i don't see an acquisition, then share repurchase makes more sense.

Michael McCallister

First, let me say it's not burning a hole in our pocket, let me make that clear. So nothing really has fundamentally change. Obviously, we had great cash flow for the quarter. We're positioned beautifully to do what we need to do strategically. We continued to look at things constantly in terms of the types of things we've shared with you in the past. Around our base businesses, as well as some purple types of things. So we'll continue to do our work, try to find the best use of that cash. We will continue to do that. You saw that we, in fact, bought a few shares this last quarter to kind of keep our toe in the water there and will do so going forward when it makes sense. So nothing has fundamentally changed. I just think it's a pretty high-class problem to have right now given some of the inflection points we're looking at relative to health insurance reform and that sort of thing. So I like where we are.

Kevin Fischbeck - BofA Merrill Lynch

Is there a good time though where you think things might shake out? Or any data points in particular that you're looking forward to, to kind of gauge when things might change and allow you to deploy that capital.?

Michael McCallister

We can never drive the timing of these things, but I would expect some things to occur over the next year or so. We've got a lot of our lions under fire, but nothing to report today.

Operator

Your next question comes from the line of John Rex from JPMorgan.

John Rex - JP Morgan Chase & Co

I want to follow-up on your comments on severity and severity coming in better. So typically, when you thought about the economic impact of low utilization, it's been kind of a more practitionally primary care. A lot of procedures have come out and in fact, we think from the hospital reports that we see case in this index rising. So it's lower acuity care isn't occurring and using your overall severity increase for most of the hospitals. So seems like you're kind of seeing something different. I just want to get a little more color about what do you see going on in terms of depressed utilization that is biasing away from what you would think could be a kind of more emergent stuff to the more primary care.

Michael McCallister

I think that last comment is really what it is personally, when we look at it slightly shorter stays, less intensive procedures, more monitoring around the care that's given, again, as an industry and particularly us as a company. And this comes back to the administrative spend we talked about before. We're getting better at figuring out what the appropriate care is and making sure that the people who really need that care get it. And again, continuing to bargain for rates. And so we put the baseline rate with the severity and talked about them together, but says it was mostly severity.

John Rex - JP Morgan Chase & Co

And are you seeing something different? Again, I'm seeing case mix index rise across all the hospitals because lower duty stuff is not happening, and so you're seeing kind of the opposite. I'm just wondering if maybe you're breaking it out different when you're talking about the severity actually coming down where we're seeing mingle and that everywhere else?

Michael McCallister

It could be. Again, the way we think of severity, again, has to do with when you look at a given procedure, you compare that procedure to the prior year and prior periods. It seems to us that there's less and there's less complexity in the cases. And again, as an industry, and us as a company, making very sure that the appropriate care has been given and being given to the appropriate patient.

John Rex - JP Morgan Chase & Co

And the underlying trend there being kind of similar between your Government program books and your Commercial books in terms of this?

Michael McCallister

Actually, not so much. There, again, in terms of the Medicare, as Mike has mentioned and as we've talked at length and you'll see when you come later this month, the 15 percent Solution has a lot to do with how care is administered and how we help coordinate care, and integrate care for better costs, for lower costs, for better quality, for better outcomes. So that part, we can look that. What I was speaking more of and when I talk more about these trends, I'm talking more about what the Commercial looks like.

John Rex - JP Morgan Chase & Co

And then not to jump too far to your point on later on this month, but you've kind of actually laid out in a way a couple of the maybe headwind and tail winds to getting some operating earnings growth next year and I wondered if you could just go through that, just frame up just broadly. I know you're not giving us earnings numbers till a few weeks from now, but broadly could you say what the big blockers are to achieving operating earnings growth next year?

James Bloem

I think the best thing to do really, John, is to wait until you come here because it is a story that takes a long time to tell that's why we're going to devote a half a day to it. We'll be issuing the guidance I have on the same-day as that. So I have a great feel of time to go through each of those factors. The ones that we've mentioned today, though are the major ones and again, but there's again a lot of new answers and there'll be a lot more questions, I think, if we get into a summary and go on with that. We'd much rather have everyone plan on coming for the half day on November 18.

John Rex - JP Morgan Chase & Co

I mean would your expectation be that you should be able to achieve some operating earnings growth next year?

Michael McCallister

Well, we'll get into that on the 18th. You've heard the big items there, the Medicare Advantage is going to grow, we've got an interesting opportunity with the PDP, product with Wal-Mart, that's likely to grow. We've got some challenges on the individual business relative to the MLR and I think beyond those major headlines today, I think we'll just wait till the 18 to get into.

Operator

Your next question comes from the line of Ana Gupte from Sanford Bernstein.

Ana Gupte - Bernstein Research

Just going back to the Medicare per debits, I think your margins are somewhere in the high singles as I understand. Can you tell us a little more, quantitatively, what your expectations are in the base case a little of the margins with this new product design? And then in terms of downside risk to those margins, either if the new membership trades down and you have lower co-pays or the health risk is less predictable, can you point to some elements of the preliminary design and how you're managing risk around that?

James Murray

We prefer not to talk about the profitability of any of our individual products. We have a nice margin on our PDP that fits in our 5% framework that we've talked with you about before. What we are anticipating with Wal-Mart also fits in that 5% framework. We've done all kinds of scenarios to identify the best case and the worst case. In terms of risk selections and we feel comfortable with the $15 pricing that we put out there. The formulary is tighter than our existing PDP formulary. We think it's a good formulary. The Government has to approve it. We think it fits nicely with the overall Wal-Mart program and we feel comfortable that the $15 and the structure of the benefit program will allow us to produce a profit, that again, fits within the 5% framework that we've talked with you about many times.

Ana Gupte - Bernstein Research

Switching gears then to Medicare Advantage, there have been a couple of transactions, one was the HealthSpring in bravo and then mimicry recently picked up Windsor health with sterling life. So would it be fair to say that your strategy seems to be more growth through organic approaches and you feel comfortable that you don't need to engage in transactions? And then, can you give us some color on how you see the competitive landscape evolving across your self in United, Kaiser, to Commercial players, and then possibly the smaller guys consolidating more actively?

Michael McCallister

Well, I think the future of Medicare Advantage is consolidation. The requirements that we're going to be dealing with, whether it's MLR, whether the cost of healthcare, we call it a 15 percent Solution, all those things are going to require investments, a lot of focus and execution and it's good to be difficult for smaller players to hang in there. So I think longer-term, you're going to see a couple of national players. You've named the other one. I think some of the smaller plants will ultimately do with these folks have been doing, which is sell out, and we look at those things whenever they pop up if we're given the opportunity. So we're not opposed to doing acquisitions. We've done them in the past in Medicare and if we can find a good plan that's got a decent infrastructure and physician community, then we would be most interested in it. Having said that, we have awful a lot of confidence that I think we've displayed over the last few years that we have the ability to grow organically. And as more moving parts are thrown into this, which is what we had with health insurance reform, I think that's actually an opportunity for us as it does sell to do quite well on Medicare. So we remain very focused on it, well buy if it makes sense, we'll grow organically under all circumstances and I think the future's pretty bright as long as there's good execution around the 15 percent Solution.

Operator

Your next question comes from the line of Peter Costa from Wells Fargo Securities.

Peter Costa - FTN Midwest Securities

Can you talk a little bit about the CIGNA joint venture and how the marketing event is going at this point?

Michael McCallister

We're underway with it. We said in the beginning it is probably more of a 2012 type of thing that it is in 2011. We've been working to get our act together and I think we're well down the road and I think there's big opportunities out there. There's about 11 million people that are getting retiree health care. And I think that represents a nice future opportunity for us as we fine-tune our relationship with them and our ability to give to these employers and show them the value proposition. I can tell you that the value proposition looks very, very good when you sit down with these employers. And It's just a question of how inertia-bound are they? What's their real interests relative to their retirees? And I think it's a nice opportunity, just one of many inside of this Medicare space.

Peter Costa - FTN Midwest Securities

They're on track but not really adding to January group of Medicare business?

Michael McCallister

No, I'd look to '12 before you start to see traction there.

James Murray

We're seeing some small sales. So the relationship is starting to develop and we've got some small successes, but again, this 2012 looks like where we're headed.

Peter Costa - FTN Midwest Securities

Then just one more piece of clarity of the $0.06 of negative operating performance in the fourth quarter, is any of that incremental marketing spend on top of the, say, the $0.28 that you talked about last quarter for added spend in the fourth quarter?

James Bloem

Yes, it is, and I looked to it earlier, but I didn't quantify it. But yes, it is in terms of -- we have because of the shorter selling season and because of all the non-Wal-Mart pieces, again, these are the kinds of things that help us grow membership, not in the Wal-Mart, but in the other places, help us lower medical costs. We talked earlier about Humana Cares and how we're working hard to get the top 5% of our most chronically I'll people into more integrated care and we're working hard on that. And also, the kinds of things that give a small over year administrative cost savings. So those are the kinds of things that are in the fourth quarter that are not the Wal-Mart.

Peter Costa - FTN Midwest Securities

So is it all that $0.06, is it all added to the $0.28 so it's like $0.34 now of incremental marketing and advertising spend? Or there is something else in there?

James Bloem

It's all in there, but it's not explained by that totally. I mean, there's probably about $30 million to $40 million of additional things for the things that I mentioned.

Operator

Your next question comes from the line of Carl McDonald from Citigroup.

Carl McDonald - Citigroup Inc

I just wanted to see if you have a sense of how the transition from Private Fee-for-Service to the new network products are going. Does the seniors how to opt out of it, is there any sort of milestones that you can look to? Or is it simply just hoping to not get the notification that they're opting out?

Michael McCallister

One of the things we say around here is, the people can vote with their fate. Currently, our PTO membership has grown from the year end of 352,000 up to 646,000. So I would suggest that, that's a pretty solid demonstration that folks are comfortable with the networks that we've assembled. I think as time goes on, and Mike has shared this with a lot of you in the past, the baby boomers have grown up being comfortable with PPO kinds of products and as we create relationships with the seniors that we serve, I think they get to know Humana and appreciate what Humana does and are willing to accept some network as opposed to the indemnity kinds of things that came with the Private Fee-for-Service offering.

Operator

Your next question comes from the line of Doug Simpson from Morgan Stanley.

Doug Simpson - Morgan Stanley

First, sort of a housekeeping question, the $0.14 that you broke out for reserves strengthening for individual at Q2, is that still in your Q4 expectation?

James Bloem

Yes, it is.

Doug Simpson - Morgan Stanley

So that was included in the $0.61?

James Bloem

Correct.

Doug Simpson - Morgan Stanley

And then a lot discussion around trend that the comments that it's obviously coming in lighter than the expectation, and you commented do you expect it to ramp overtime? Just in helping us to think about the timing and the way that would impact the numbers, if we think about what you've seen this year and the changing benefit designs, do you expect a bigger ramp in Q4? And then a subsequent bigger dip in Q1 if we hold through constant, which obviously could be a swing factor? Just thinking of the next six months, how this may present itself in the numbers.

Michael McCallister

I don't think those things can actually be known. We're in the middle of an economic situation that this country hasn't seen in decades. So we were seeing last year in '09, some ramp up of healthcare expenses, we think people are moving all their spending forward as they're worried about losing their jobs. I think we've seen a whiplash on the other direction this year, but there's really no way to know exactly why it's doing what it's doing. So as you look forward, I think the smartest thing for us to do is not assume the level of news we have today going forward because this industry, I've been around a longtime, has been through this before for some reasons expenses have softened up and people started adjusting prices and they always miss the bottom of that when it goes back up again. So we are going to be cautious here. We're going to assume that we get back to more normal rates in the future and that's just our ongoing assumption at this point and it's going to take an awful lot of more data and time for us to get comfortable that we've seen a sort of a permanent change.

Doug Simpson - Morgan Stanley

But as you slice and dice the different offerings across your book, is there any intelligence to be gained from that as to how much of it is going to be sticky and persist longer term and how much of it is sort of a factor, just the exhaustion as factors you're talking about?

James Murray

I don't know that we have everything that would give us great insight into that right now.

Doug Simpson - Morgan Stanley

And then maybe I'm just thinking about the commission changes that we may see, the logistics around that, how should we think about that flowing into the market with respect to both timing and mechanism? How is that going to be communicated, just that process, how do you see that playing out?

James Murray

This Jim Murray again. It's kind of interesting. It looks like everybody is going to wait for everybody else to do something with respect to the commissions and we're in that camp. We've seen two companies, commission structures come out and most of the commission changes, frankly are impacting the individual business. The small group where we've done a lot of studying around that and trying to figure out what we need to do, but frankly, small group for us hasn't been as impacted by health care reform as individuals. So I think what'll happen is, that sometime in January, everybody's going to lay their cards down and we'll try to react accordingly. We've seen again two other company's programs and we feel very good about what we've got coming out. One of the things that we'll share with the brokers that serve us, is that we are making available lots of other kinds of products and services, trying to make it easier for the brokers to do business with us. And so to the extent that we reduce our commission levels, hopefully they can make up some of that by participating in our other programs. And so I think we've got a nice rollout plan. We're waiting for a lot of other folks, so you'll see us rolling out a lot of information in January. We've got a nice tactical plan around that and we feel reasonably comfortable that we'll be in good shape. A lot of what has to happen over the next several years is we've got to move to other distribution channels and we're in the process of doing that. And I think others will do that over time as well.

Doug Simpson - Morgan Stanley

And should we think about that timing of that as lining up with the way it plays out with respect to phase-in periods to the exempt or granted?

James Bloem

Sure.

Operator

Your next question comes from the line of Joe Freds [ph] from Gleacher & Company.

Unidentified Analyst

Jim, in your August guidance, you had $0.14 of incremental policy reserve in the major individual major policy claims. Is that still in the guidance? What is it? And is that a fourth quarter item?

James Bloem

Yes, it is. It' still in the guidance. And again, there were some in the third and some on the fourth equal amounts of each, just $0.07 and $0.07, if you're looking for the $0.14. It has to do with again, strengthening the reserves, the individual business basically helping it move to the near 80%, let's say required at the minimal MNR threshold requirement.

Operator

[Operator Instructions] And your next question comes from the line of Dave Windley from Jefferies & Co.

David Windley - Jefferies & Company, Inc.

Mike, in your prepared remarks, you talked about managing the Commercial Group business for profitability. I wondered if those comments implied any more aggressive moves going into 2011 around that business? Any change in strategy or trajectory there?

Michael McCallister

I don't know of anything significant but I was referring to a couple of things. One is, We're not going to price to the current cost levels and as a result we may lose some business if we have competitors, that in fact are willing to cast their fate with that. So we're just not going to chase that. We've been in this posture for quite a while. I mean, this company has done very, very well in the back of Medicare and some other things. We haven't had the same sort of pressures to have Commercial do but I think that others had to do. And I think we're still in that spot. So we can be smart, we can be cautious and our success is not going to be driven by dramatic, Organic, Commercial business. So we can be cautious and that's what we're going to do.

David Windley - Jefferies & Company, Inc.

And Jim Bloom, on the guidance, I want to make sure I'm understanding the fourth quarter impact. that It looks like to me if I take all the mid points, then the amount that you are not flowing through this quarter is upside to fourth quarter is about $0.11, it looks like $0.06 of that is TRICARE. Have you touched on the other $0.05? Is that the marketing spend that you mentioned to Peter, or am I calculating this wrong? Or is this something else?

James Bloem

It's basically that marketing spend that's close to the amount. There always are a number of variables, the pluses and the minuses, but the biggest factor would be what I would call a non-Wal-Mart investment spending to get ready for 2011.

Operator

Your next question comes from the line of Sarah James from Wedbush.

Sarah James - Wedbush Securities Inc.

I'm trying to put together some of the pieces surrounding your pricing and cost-turned assumptions. You mentioned this morning that 2010 benefited from care management coordination and giving the appropriate levels of care and how this positively impacted your bad days per procedure or total expenditures per procedure. And then you also mentioned in 2011 that you expect trends to return to normalized levels, which is up about 200 to 300 basis points or so. So can you just conceptually walk us through some of the cases of how you got back up to that level next year?

Michael McCallister

Sarah, again, when we talk about that 300 basis points, that's really a Commercial, and we're looking at a trend and the trends I mentioned in the guidance, back in the Commercial part of the business. Again, as Mike and Jim has said, that's the smaller part of the business that's basically 10% of our pretax. The other part is our Medicare part, that's where we talk about 15 percent Solution and that's where we talk about how give the, as I've mentioned, the appropriate care to those patients who most need it. And that part, again, has helped us and has helped explain, again, how we can continue to keep premiums and benefits level in a year where, again, we've got a 10% challenge in 2010 and we're now saying that overall as a company, we're probably, our earnings will be the best that they've been. We also face the '11 situation where we have in Medicare a 5% trend and we're not getting any increase in rates. Again, we feel good about that. We'll talk more to you about that on the 18th. But again, thinking about those two things, one Commercial and the other Medicare, and then that's how we respond to what has generally improved performance have we talked about today.

Michael McCallister

Let me just follow up and then I'll say it one more time. We don't have everything in front of us that says, expenses are going to go up in the Commercial business next year. All we have is experience and we've seen a strange '09 relative to utilization. We're clearly using a strange '10. So We're in sort of an odd spot right now in terms of trying to predict what medical expenses are going to look like next year. And all I've said, in order to be conservative about our outlook, and not give ourselves in some sort of a buying, we're assuming more normalized numbers for next year. But I don't have anything in front of me right now that from a data perspective that would say that's going to happen.

Sarah James - Wedbush Securities Inc.

And then on your part B strategy, I just wanted to understand a little bit about the seniors purchasing decision in light of the positive disruption that you're creating in the market this year. I know you mentioned that you're announces should decrease in confusion in senior is there nationwide price would be an important factor in selling the product and one of your competitors shared some of theirs. And now ours is showing that on their book, seniors preferred your deductible, and I know that differs from your strategy this year with Wal-Mart with the low premium and the year end $10 deductible. I was wondering if you could just give us any color on your analysis, maybe showing if you found seniors will prefer the lower premium or anything else driving your purchase decisions.

Michael McCallister

You were breaking up at the end of that, I didn't get the end of it.

Sarah James - Wedbush Securities Inc.

Sure, I was asking if you could share any of your analysis around the seniors purchasing decision if it showed that they will prefer the lower premium over the zero deductible or anything else that would be driving their purchase decisions?

Michael McCallister

No, I'm not going to get specific, but I will tell you we've studied seniors buying patterns extensively and we know that they segmented into different groups and to think that they're homogenous group would be wrong, they're not. And so, certain people are attracted to certain product designs that's why we have more than one product on the street. Some are focused on the benefits specifically, some are focused on the premiums. And knowing who they are and how to approach them is sort of the secret sauce around here in terms of being able to sell. So we know that this Wal-Mart offering is going to appeal to a pretty wide swap of folks because of this low premium in a way that it's structured and the fact that brands attached to it are quite strong. So all of that matters, we studied it. We continued to do it. We want to get better and better over time and knowing how to reach the market and we've learned a lot in just the last four years and in an area where you're going to have pretty short selling periods, you better be very good at this, so we think it's a critical component of how we operate our Medicare business just to understand how to approach these people. And if we've tripped a couple of times as we've learned this business, as some of you know, but right now I feel pretty good that this particular product is very focused on a pretty wide swap of the population, but it is built on the back of our understanding of what people want.

Operator

And your last question comes from the line of Tom Carroll from Stifel, Nicolaus.

Thomas Carroll - Stifel, Nicolaus & Co., Inc.

Just a quick last-second clarification, on your MA growth comment, were you speaking from a net expectations perspective? I missed that.

James Murray

On a net basis, yes.

Operator

There are no further questions in the quarter.

Michael McCallister

Okay, terrific. Well, Thanks for joining us this morning. We have a lot of work ahead of us. We have a lot of people in this company implementing our health insurance reform bill and we are fully engaged in doing that and we're pleased with the quarter. The year looks good. We're excited about what Medicare is going to do for us in January. We look forward to seeing all of you later this month and I'd like to thank all the Humana associates that are on the call for making this great performance possible. Thank you very much.

Operator

This concludes today's conference call. You may now disconnect.

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