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Universal American Corporation (NYSE:UAM)

Q2 2014 Earnings Conference Call

July 29, 2014, 09:00 AM ET

Executives

Richard A. Barasch – Chairman and CEO

Anthony L. Wolk – SVP, General Counsel and Secretary

Robert A. Waegelein – President and CFO

Analysts

Kevin Fischbeck - Bank of America Merrill Lynch

Sarah James - Wedbush Securities

Carl McDonald - Citi

Operator

Greetings and welcome to the Universal American Corp., Second Quarter 2014 Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Richard Barasch, Chairman and CEO for Universal American Corp. Thank you, sir. You may begin.

Richard A. Barasch

Thank you, and good morning, everyone. Thanks for joining us on our second quarter 2014 conference call. I’m here with our President and CFO, Bob Waegelein; and our General Counsel, Tony Wolk.

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

Anthony L. Wolk

Before we begin I would like to remind you that we have posted a presentation for this call in the Investors section of our website at www.universalamerican.com. I would also like to remind all participants that our call this morning may contain forward-looking statements within the meaning of the federal securities laws. These statements, which reflect management’s current expectations, projections and beliefs, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of these risks and uncertainties we recommend that you review the company’s risk factors and other disclosures set forth in our SEC filings. We undertake no obligation to update or revise any forward-looking statements to reflect events, developments or circumstances after the date hereof.

During the call we will also be referring to certain non-GAAP financial measures. Please refer to the reconciliation tables listed in the press release for a discussion of these non-GAAP financial measures. Richard?

Richard A. Barasch

Thanks, Tony. In the aggregate, our financial results are still not where we want them to be, but we are making progress towards the goals that we established to clean-up or eliminate the items that detract from the solid businesses at the heart of Universal American, and to set our base for future growth. We firmly believe that our future lies in having our focus -- our company focus its energy on programs and locations where we can partner with providers, especially primary care physicians to improve the quality and reduce the cost of healthcare. This has worked and will continue to work quite well for us in Medicare Advantage. Even though, our ACO business has been slower to emerge than we anticipated, I am quite sure that the scales that we and our partners are developing will be of great value as payment reform accelerates.

In our first quarter call, I discussed the following key initiatives; reducing our MA business to its profitable core, reducing our expenses both at the segment level and overall, right-sizing our investment in ACO, reducing the drag from the APS transaction, and finally harvesting excess capital and using it appropriately to right-size the company for future growth. I am happy to say that we've made notable progress with each of these items and expect more to come through the remainder of the year. I'll be more specific on each item after Bob reports the financial results. Bob?

Robert A. Waegelein

Thank you, Richard. I'd like to remind you that we’ve posted additional information on our operating results in the financial supplement that can be found on our website in the financial reports tab of our Investor section.

Let's turn to slide five, and you will see for the second quarter, we reported adjusted pretax income from our operations of $7.4 million. As a result of the Affordable Care Act’s mandated non-deductible expenses for ACA fees and certain executive compensation as well as our non-deductible preferred stock interest expense, our effective tax rate on our operating results for the quarter was 86.5%, resulting in an after-tax income of $1 million or a penny a share.

Our Medicare Advantage business continued to perform well in the second quarter, with pretax profits of $12.8 million on $358 million of premium. Our reported MBR was 83.1%, which excludes $8.1 million of quality initiative expenses that are historically reported in administrative expenses, but are now reported as a component of total benefits. After taking into account prior positive period items, our adjusted MBR was 86.2%.

Taking a look at our six months results on slide five, it will be more informative to reviewing our segment operating performance. For the six months, our Medicare Advantage business operated solidly earning $37.7 million on $714 million of premium. For the six months, the reported MBR was 81.2% and was aided by $28 million of favorable items relating to 2013.

Excluding these items, our adjusted Medicare Advantage MBR was 84.9%. However, let's look at slide six and you will note the disparity between our core and non-core MA businesses. After eliminating the out-of-period items and excluding quality initiative expenses, the core market’s MBRs for the quarter were 84.1% for HMOs and 85.8% for our Northeast market, and for the six months they were 82.6% for HMOs and 84.8% for the Northeast. These MBRs are within our expectations as we generally see slightly higher MBRs in the second quarter, and we believe that the MBRs will trend downward through the balance of the year as they have over the past several years.

As important, the continued development of the full-year 2013 MBRs were favorably impacted by the prior period items which provides a solid base for our bids for 2015. Not surprisingly, the weakest results were in our non-core network and rural private fee-for-service businesses. For the six months, adjusted MBRs for these products were 91.3% in non-core network and 96.4% in rural private fees. As a result, we did not submit bids for these non-core markets in 2015.

Returning to slide five, our administrative expense ratio for MA was 10.8% for the six months ended June, the same rate as last year despite a reduction in our membership and premium. We continue to address our administrative scale, and Rich will comment more on that later.

For the six months, the traditional business had 3.3 million of pretax profits with the loss ratios in our Medicare supplement, DI, and long-term care businesses performing as expected. As a reminder, this business is in run off and accordingly profits will reduce overtime.

Finally, our corporate segment includes the results of APS healthcare, the Total Care Medicaid plan, and the operations of our parent holding company including its debt service. For the six months ended June, the segment reported a loss of $21.5 million with Total Care reporting a pretax profit of 2.1, APS recording 200,000 of income, and other net corporate charges amounted to $22 million. The operating cost for ACOs in the second quarter were $10 million, down from the $13.1 million in the first quarter for year-to-date amount of $23 million or $15 million after tax. CMS indicated that we will receive information regarding the results of the first program period late in the third quarter, and we expected that this information will likely show some savings in the revenue.

Moving to page seven, we show the balance sheet. As of June, we had $2.1 billion in total assets, including $39 million of unregulated cash at the parent. This is down from the $79 million amount at March as a result of the $6 million share repurchase we completed in May at a price of $6.03. When we exclude all other intangibles, the deferred acquisition costs, goodwill, and other intangible assets, we ended the quarter with a tangible book value per share of $5.59.

Finally, the total capitalization ratio as of June was 18.9%, a small increase in the March amount as results of the impact of the stock buyback. Richard?

Richard A. Barasch

Thanks Bob. Turning back to slide six, I’d like to amplify some of Bob remarks about Medicare Advantage. First, as Bob said, 2013 competed very favorably which he also said bodes very well for 2015 bids. Second, the core -- the current MBRs in our core markets even when you back out the prior period development are in good shape. Third, the MBR’s in our non-core markets continue to be a drag on earnings. Consequently, we decided to submit 2015 bids only where we can impact cost and quality of healthcare. We will be exiting our non-core markets beginning in 2015.

Finally, we have begun to implement our plan to significantly reduce administrative expenses which we expect will result in our ALR falling to approximately 10% in 2015, even taking into account the headwind resulting from our reduction in membership.

Now turning over to slide eight, starting with Medicare Advantage, we have identified our core markets in which roughly 85% of the members are covered by plans with 4 Star ratings, and will continue to concentrate our efforts to appropriately reduce medical costs and improve quality in those markets. We are pleased with the results of the quarter in the core markets held by prior period positive development from the prior year, which we have come to expect. As Bob noted, we generally see higher MBRs in the second quarter and believe that the MBRs will trend downward through the balance of the year as they have over the past several years.

The combination of our completed 2013 results, our current results and the additional revenue derived from the 4 Star rating in our core markets provide a solid balance for the 2015 bids. We believe that our plans will be quite attractive in the market and we are looking forward to the 2015 selling season with great anticipation.

Our HMOs in Texas continue to perform well and we are seeing particular improvement in our North Texas market due to improved provider contracting. I should note here that we have entered into contracts to sell our Oklahoma plants. As has been the theme for us we are eliminating all plants where we cannot complete favorably over the long run. When the Oklahoma MBR experience is eliminated from the table on page six the remaining MBRs in our HMOs are even more favorable.

As I’ve often stated Medicare Advantage will hold up well only where we can impact the cost of care improved quality. In our HMOs this is largely accomplished through our partnership with primary care providers and while there has been and will continue to be vibrant to its reduction in benchmark rates enacted by the ACA.

We are especially excited about our prospects in Houston and [Beaumont] where we enjoy our market leading position and it’s powered by long standing and successful partnership with primary care providers. We believe that our position will be further solidified by our membership growth in 2014 and the positive effect of increasing our stars in our 2015 bid and products.

Along with the Texas HMO we have identified core markets in upstate New York in May where we have a history with providers due to a concentration of membership and long history in the market going back to our [inaudible] days. We now have a complementary collection of assets centered in Upstate New York where we serve nearly 30,000 Medicare Advantage numbers, 13,000 Medicare fee-for-service beneficiaries through our ACA partnership and nearly 40,000 Medicaid lives through the Total Care acquisition that closed late last year.

We believe we can improve the profitability of the plants through network recontracting and closer relationships with our primary care docs. The improvement in our star ratings in the northeast is not only a mark of improved quality but also a mark of greater cooperation with physicians in these markets.

Turning briefly to slide nine, we were able to see the tangible benefit of our increased star ratings for 2015. The focused effort to improve the quality of our plants for the benefit of our members has clearly paid off. With the pending sale of our Oklahoma plants, nearly 85% of our remaining members are now in plan to -- that have achieved a four star rating including our two biggest plans in Southeast Texas and New York. Not only did we make absolute gains which will have a significant revenue implication for us in 2015 we made relative gains as measured against key competitors in all of our core markets.

To be some more specific we did not bid in any of the non-core markets and this brought us several benefits. First, we can focus our energy in our core markets where we have a chance to continue our membership growth and further improve delivery of healthcare with our physician partners. Second, the simplification of our structure will allow our admin to be more efficient and cost effective and finally we will be able to harvest the capital that has been supporting that business.

When the Medicare Shared Savings Program emerged from 2010 Health Reform Bill we anticipated that the sort of techniques that we have used in our successful and enduring partnerships with primary care physicians in Texas will also work in that fee-for-service population. Two years into the Medicare Shared Savings Program we remain firmly committed to our ACO business and are beginning to see encouraging data that demonstrates that we are positively impacting medical costs to reduce hospitalization, reduce re-admit rates and reduce [DR] business. We expect that our results for 2013 will likely show savings in revenue. Nevertheless we continue -- we're continuing to reduce the size and scope of our investment to focus those on those ACOs where the MSSP program can work, where we can truly impact the cost and quality of medical care.

We are actively working with our ACO provider partners to deploy the care coordination techniques to close gaps in care and reduce overall costs. Specifically we've identified the higher risk members with chronic condition and are actively coordinating their care with on the ground case managers in cooperation with your primary care physicians. We’ve also rolled out a new portal that will provide actionable data and analytics to the physicians which will enable them to manage the care of their patients more efficiently.

In addition we're working on creative approaches to enhance our engagement with the healthier beneficiaries so they can take a more active role in the overall quality and cost of their healthcare. It's important to reach out to these individuals or rather primary-care physicians to stay informed as to their health conditions.

Lastly we're beginning to work with several of our provider partners on expanding our relationship beyond the Medicare Shared Saving Program, which could include Medicare Advantage and MSO type offerings for commercial business. Even though the results are emerging slower than we had hoped we believe we are building distinctive and important business for Universal American. The skills that we and our physician partners are learning will no doubt prove to be valuable as payment reform continues.

We're also making progress on improving EPS. In aggregate EPS with EBITDA positive for the quarter excluding legal fees related to the pre-acquisition matters. In admission, we had a good short-term development in Puerto Rico which we hope will be followed by longer-term stability.

The Medicare RFP that was supposed to have been completed by June 30 was delayed until this fall with a start day of April 2015. We were able to negotiate and execute a renewal of our contract on terms that should allow us a reasonable margin over this nine month period. As expected the Managed Behavioral Health program that APS is currently performing will now be carved into the overall Medicaid benefit as part of the new RFP. We are in active discussions with several of the prime vendors to provide the behavioral health component and expect to hear the results in the fourth quarter.

Despite the disappointing experience we have had with APS there are very hard working and talented people in APS and we remain committed to providing the highest level of service to our existing state and health plan clients.

Now few comments on capital; we will continue to return excess capital to our shareholders and as stated above one benefit of shrinking our MA footprint is a reduction in the amount of capital needed to support the business. As of June 30 our tangible book value is $5.59 per share and after despite a soft buyback we still have a $140 million of excess capital not yet factoring in the excess capital from reducing our MA footprint. As noted earlier non-renewal of the non-core business will be particularly helpful in the first half of 2015 when we expect at least $70 million to be freed up. We closed our $6 million share buyback during the second quarter. We purchased these shares at $6.03 a share just over tangible book value. These actions are consistent with our commitment to use capital prudently and return capital to our shareholders that we are not fully employing in our business.

Bob and I were happy to have the opportunity to participate in this deal to acquire the shares that [Capital Z] acquired nearly 15 years ago. We know we have work to do to restore Universal American to a path of creating value and as I said at the top we have a base of excellent core businesses, more than sufficient capital and a commitment to eliminate the financial and strategic distractions. When the dust settles we plan to have an appropriately capitalized company which is focused on working with producers, especially primary care physicians to improve the cost and quality of healthcare.

Thanks for your time this morning. Bob and I will be happy to answer your questions.

Question-and-Answer Session

Operator

Thank you. At this time we will conduct a question-and-answer session. (Operator Instructions). Our first question comes from the line of Kevin Fischbeck with Bank of America. Please proceed with your question.

Kevin Fischbeck - Bank of America Merrill Lynch

Great, thanks. You talked about 2015, I think you will be able to get to, I think you said 10% G&A level, does that number -- is that just on the health plan business, does that exclude like the ACO investments?

Richard A. Barasch

Yes, that’s purely on the healthcare, on the Medicare Advantage business.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay, it’s purely on the Medicare Advantage Business. Okay. And then I guess you have outlined a lot of things you are doing as far as next year goes. Obviously, you are shrinking the footprint, focusing on where there is profitability, focusing on right sizing the G&A, but can you talk a little bit about what happens with the company after that, is 2016 going to be a year where membership is growing, what kind of long term, what do you expect?

Richard A. Barasch

Yeah, I think once we get to – that’s a good question, once we get to this space, I think we grow from this space. If you look underneath the numbers and go to the core, we have been growing in the core for the past several years in the aggregate. So when you eliminate some of the noise in the non-core markets, we have been growing there and we think we will continue to grow. We grew 13% in Houston last year in the Houston- Beaumont market. We are hoping to have at least as good a year this year. This will be our first year with four stars as an example. New York, we had a little bit of a down year in New York last year, but that was after several years of growth. After that, we now have four star plans. We think we have done the right thing with our benefits relative to our competitors, so we are actually pretty optimistic that we are going to see some growth there as well.

So, our plan is really based on pruning that which isn’t working for us, you could see we are getting rid of a lot of business that have very high loss ratios, concentrating on places where we have more favorable loss ratios and employing our energies into all aspects of the plans in those markets.

Kevin Fischbeck - Bank of America Merrill Lynch

Is there a sense of what you think normalized margins might be over time or a target about long term top line growth …?

Robert A. Waegelein

That’s a tough question, that’s longer term -- you first to have tell me what the call letter looks like at the beginning of ‘15, there’s a lot of factors. Each year sort of sits on its own. Even as difficult as the last couple of years have been, we’ve maintained our inherent profitability of our MA business. So we continue, I mean, that’s even with the headwinds of both higher admin costs and higher loss ratios in non-core. I think when we can solve both of those problems, you will see an emergence of a much more profitable MA business.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay and then last question, when you think about refocusing on the ACO side, I think you stated 30 ACOs, would that -- how long would it take you to unwind those, could you get out of those for 2015?

Robert A. Waegelein

Yeah, it’s pretty [core]. We are in close contact with the physicians. We are also seeing the same numbers. There is a great deal of effort on their part, and if the numbers aren’t proving out, sort of in everybody’s interest to recognize the right answer, some of the ACOs that we have disengaged with have gone on their own, and we will continue to try to make a go of that, which I am delighted about by the way, but it is a question of where our investments are.

We are trying to be geographically more, more concentrated. We still have a lot of footprint in Georgia, lot of footprint in the Washington DC and Maryland and Virginia area. We also have footprint that coincides with our MA markets which is very important for the future, because we have done these ACOs to participate in MSSP, but the longer run view here is that the ACOs that have learned how to take risk or manage risk will be able to give us not for MA, not for Medicare only, but should be able to do this for other businesses as well.

Kevin Fischbeck - Bank of America Merrill Lynch

Okay great, thanks.

Operator

Thank you. Our next question comes from the line of Sarah James with Wedbush Securities. Please proceed with your question.

Sarah James - Wedbush Securities

Thank you. You alluded to in the press release returning money to shareholders, and historically a key method of that would be a special dividend, is that still a strategy in place?

Robert A. Waegelein

I think we were more specific about returning money to shareholders. We executed a fairly large buyback last quarter, which we thought was a great use of share of company money for the benefit of shareholders. And sort of the way it’s been fair over time is when we have excess capital and we don’t have a use for it at the company level, and clearly now as we’re shrinking -- particularly shrinking our MA footprint, the need for capital is less. So the likelihood is we will want to return it, and the form which we return it will be depending on the situation as it works at that point.

Sarah James - Wedbush Securities

Great, and then about the capital levels in the slides it looks like there was a $50 million being freed out in 2015.

Richard A. Barasch

That is close to $70 million, Sarah.

Sarah James - Wedbush Securities

70, got it, and is that inclusive of the Oklahoma or is that just non-bid?

Richard A. Barasch

No.

Sarah James - Wedbush Securities

How much more could be available.

Richard A. Barasch

Oklahoma is going to be, give or take $15 million.

Sarah James - Wedbush Securities

15, got it. And could you talk about what margins may look like post getting Oklahoma off your books and maybe some other markets?

Richard A. Barasch

We need to really talk about, you know, we have been pretty good about not going forward on margins, where are a lot of it depends on how much we sell next year, sort of what mix of membership looks like, just a variety of factors. So we are just kind of reluctant to really talk about that.

Sarah James - Wedbush Securities

Can we presume that Oklahoma was kind of a on the lower end?

Richard A. Barasch

Oh, yeah definitely you can assume it.

Sarah James - Wedbush Securities

Okay, I think…

Richard A. Barasch

That is a good assumption, I think the overall scene is that we have eliminated markets which on a per forma basis don’t give us the sort of margins that we think are appropriate for this business.

Sarah James - Wedbush Securities

Got it, that’s very helpful, thank you.

Operator

Thank you, ladies and gentlemen, (Operator Instructions). Our next question comes from the line of Carl McDonald with Citigroup, please proceed with your question.

Carl McDonald - Citi

Thanks, be interested in the work that you guys have done around applicability of industry fee to exited markets. So I guess there maybe two nuances is if you sell the Oklahoma plant, does the buyer pay the full industry fee next year or you are responsible for at least a portion of this year? If a subsidiary shuts down entirely but the parent company is still around, would you pay the industry fee on that shut down subsidiary.

Robert A. Waegelein

It’s a good question. In the Oklahoma deal we contractually dealt with it, the plant owes the fee, we don’t own the plant anymore. They pay the fee so that’s easy. On discontinued it’s a bit more complicated call and kind of everybody is sort of looking at this and no one has got the right answer just yet.

Carl McDonald - Citi

Got it. And on the Oklahoma sale, is the buyer buying the entire company or just buying lives.

Richard A. Barasch

Yeah, part purchase.

Carl McDonald - Citi

Okay, thank you very much.

Operator

Thank you. Mr. Barasch, there are no further questions at this time. I would like to turn the call back to you for any closing comments.

Richard A. Barasch

Yeah, thanks everyone for your time this morning. I look forward to seeing you at conferences and I will be speaking to you at the end of the third quarter. Enjoy the rest of the summer.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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