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Executives

Jack Larsen - CFO, Public and Senior Sector Group

Gail Boudreaux - Executive Vice President and Chief Executive Officer of United Healthcare

Dan Schumacher - CFO, UnitedHealthcare

Tom Paul - COO

Stephen Hemsley - Chief Executive Officer, President and Executive Director

Analysts

Christian Rigg - Susquehanna Financial Group, LLLP

Joshua Raskin - Barclays Capital

Joseph France - Gleacher & Company, Inc.

Peter Costa - Wells Fargo Securities, LLC

Justin Lake - UBS Investment Bank

Kimberly Purvis

Charles Boorady - Crédit Suisse AG

Scott Fidel - Deutsche Bank AG

Matthew Borsch - Goldman Sachs Group Inc.

David Windley - Jefferies & Company, Inc.

Carl McDonald - CIBC World Markets

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

John Rex - JP Morgan Chase & Co

Christine Arnold - Cowen and Company, LLC

Kevin Fischbeck - BofA Merrill Lynch

Thomas Carroll

Doug Simpson - Morgan Stanley

Unitedhealth Group (UNH) Q4 2010 Earnings Call January 20, 2011 8:45 AM ET

Operator

Good morning. I will be your conference facilitator today. At this time, I would like to welcome everyone to the Unitedhealth Group Fourth Quarter and Full Year 2010 Earnings Conference Call. [Operator Instructions] This call and its contents are the property of UnitedHealth Group. Any use, copying or distribution without written permission from UnitedHealth Group is strictly prohibited. Here are some important introductory information. This call will reference non-GAAP amounts. A reconciliation of the non-GAAP to GAAP amounts is available on the financial reports and SEC filings section of the company's Investors page at www.unitedhealthgroup.com. This call contains forward-looking statements under U.S. Federal Securities Laws. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from historical experience or present expectations. A description of some of the risk and uncertainties can be found in the reports that we file with the Securities and Exchange Commission from time to time, including the cautionary statements included in our current and periodic filings. Information presented on this call is contained in the earnings release we issued this morning and in our Form 8-K dated January 20, 2011, which may be accessed from the Investors page of the company's website at www.unitedhealthgroup.com.

I would now like to turn the conference over to the President and Chief Executive Officer of Unitedhealth Group, Stephen Hemsley.

Stephen Hemsley

Good morning, and thank you for joining us. Today, we will review our 2010 performance and fourth quarter results and update you on actions we expect will help drive continued success for Unitedhealth Group in 2011 and beyond.

Fourth quarter 2010 continued to build on the execution fundamentals that are enabling us to better address the needs of the markets we serve. Those fundamentals of responsiveness and service, practical consumer-focused innovation and cost management to protect the affordability of healthcare helped us improve our business performance in three areas in 2010.

First, revenue growth was driven by a broad-based membership growth and higher retention across our Health Benefits businesses, combined with significant, larger customer and revenue opportunities within our Health Services businesses. Fourth quarter revenues of $24 billion brought full year revenues to $94.2 billion, an increase of 8% over 2009. Four of our businesses produced double-digit percentage year-over-year revenue growth, both in the fourth quarter and for the full year.

Second, effective cost management disciplines improved across all areas of 2010, with the Health Benefit businesses benefiting from a general moderation in healthcare consumption as well. The fourth quarter operating margin of 7.5% brought the full year margin to a solid 8.4%.

And third, we took steps to further strengthen our capital disciplines. We reduced our debt levels to the current 30% of total capitalization, giving us substantial future flexibility. We significantly increased dividend levels for the first time with a commitment to build from this starting point. We again reduced the outstanding share count by 5% year-over-year, and we expect to continue our share repurchase program in 2011 as well.

And throughout 2010, we were opportunistic in acquiring properties that strengthened the market positions of our businesses. We did this while deploying the capital required internally to keep our businesses in leadership positions, in the development and use of technology and in advancing more modern and integrated business approaches.

We reported fourth quarter earnings of $0.94 per share, which included roughly $0.125 in after-tax charges. We had improving metrics across the board and operating cash flows of $1.4 billion. Full year 2010 results included earnings of $4.10 per share, a 26.5% improvement year-over-year, with cash flows from operations of $6.3 billion. Cash flows were more than 1.3x full year net earnings.

As we said, these results were driven by strong and consistent execution on the fundamentals of medical cost management, product development and innovation and responsive customer service. And they were supported by specific actions to strengthen market image and reputation. Our Health in Numbers reputation campaign is delivering results even in its introductory stage. The simplified UnitedHealthcare branding is making it easier to do business with us across all the Health Benefits markets.

Through our Health Services businesses, consumers are learning that our vast healthcare data and resources support them in a highly personalized way, as they pursue better health and more effective use of the healthcare system. And we're making significant advances in working across the healthcare delivery ecosystem to help connect, inform, modernize and advance consistent quality and sustainable, affordable care.

Over the past two years, we have recommitted to innovation by focusing on new ideas that are practical and valued by customers. A sample of our efforts in 2010 includes the health impact suite from Ingenix, which manages patient and population level analysis and identifies people at risk for potentially serious chronic disease such as diabetes or heart disease years before onset. This suite is becoming a leading information technology serving both payers and accountable care organizations. The Diabetes Prevention and Control Alliance has been purchased by national account customers and a leading regional health plan. Together with UnitedHealthcare members in a number of our local markets, nearly 2 million Americans have access to what we believe is a groundbreaking approach in preventing and controlling diabetes. The Ingenix physician model office provides a blueprint to accelerate the adoption of health IT, making it faster, easier and minimally disruptive for physicians to implement. And the UnitedHealthcare oncology payment pilot now reimburses oncologists based on an entire cancer treatment program.

New product introductions over the last 24 to 36 months were significant contributors to UnitedHealthcare's commercial growth this year, and we have more innovative products and service efforts in development.

Our company is known for the breadth and depth of our leadership team and the way we structure distinct businesses to face and serve diverse market. This is not an accident. We've been very conscious about assembling strong, talented leaders, and we have a history of rotating them in a variety of leadership roles, offering them the opportunity to diversify their experience, as well as to learn and experience more about various aspects of our complex businesses while bringing their fresh perspectives, energies and leadership to new tasks.

We operate first and foremost as a team, collaborating and coordinating work across business segments, always keeping top of mind the best interest of the overall enterprise.

So today, we announced organizational changes that are, in many ways, a matter of a routine for us. If you follow the business model, we have been socializing for some time throughout the enterprise and with you. That is we offer Health Benefits and Health Services. Each of these two business platforms is becoming more aligned and integrated as distinct but strategically aligned business portfolios, strengthening and leveraging their capabilities without disturbing the market focus of each of the sovereign businesses within them.

The shorthand version of the changes announced today is this: Mike Mikan will begin to take on an oversight leadership for the Health Services businesses. Gail Boudreaux will oversee the four Benefit businesses of UnitedHealthcare. Dave Wichmann will take the role of CFO while retaining all his corporate oversight responsibilities. Bill Munsell, Larry Renfro and Tony Welters will join me in the office of the CEO, providing their depth of experience and management capabilities at the UnitedHealth Group enterprise level, along with expertise and experience in strategic market engagements; driving optimal business performance; pursuing opportunities for growth and nurturing emerging business concepts; developing relationship equity and alliances; and government, political and reputational affairs oversight, its issues and representation, among others. Basically, tasked to foster growth, to better position the enterprise and optimize our resources and performance.

In their new positions, all these executives report to me as they did before. This alignment and their support will allow me to dedicate more time to our strategy and further diversification of our enterprise and to build stronger external relationships and engagement across the board. I'll continue my traditional interest and focus on fundamental execution.

Going forward, you can expect even greater focus on our Health Benefit businesses as an integrated whole; on our Health Services businesses the dynamic emerging services platform; and on the UnitedHealth Group enterprise-wide leadership to drive expansion, cultivate distinct alliances and relationships and ultimately position this company for the future.

Moving to discussions of the business unit level. In Health Benefits, our UnitedHealthcare businesses had an excellent growth year, as Health Benefits revenues increased 8% year-over-year to $87.4 billion, and we grew by 1.2 million people, including growth of 230,000 consumers this quarter. Participation in Medicare Advantage increased 16%, Part D stand-alone increased 5% and Medicaid program participation was up almost 15% year-over-year.

In the commercial markets, our net gain of 185,000 people served in 2010 was a dramatic turnaround from the 1.7 million person year-over-year membership loss in 2009. The improvements were driven by newer, more affordable products, better customer retention, better service and lower employee attrition trends among our customers. Our overall customer retention rates continued to improve in January 2011, with our Commercial businesses off to a strong start this year.

Each of the UnitedHealthcare businesses organically increased market share in 2010 and also strengthened their market positions by moving opportunistically in the M&A market over the past year and a half. Health Benefits operating margins improved year-over-year in both the fourth quarter and for the full year 2010.

The fourth quarter consolidated medical care ratio of 79.6% benefited from favorable reserve development. We continue to expect commercial cost trends will return in 2011 to around 7.5% due to more normal trends in healthcare demand and added costs from the early benefit mandate on the Affordable Care Act and Mental Health Parity legislation. We are pricing to these higher costs. The newly effective minimum loss ratio requirements for 2011 are just one factor in local product pricing, which also reflects our product positioning, the competitive environment in each market and increasing regulation.

We continue to forecast a higher commercial care ratio for 2011 of 83.7%, plus or minus 50 basis points, due primarily to these new regulations and the strong level of prior-period development realized in 2010.

Looking ahead, we believe the UnitedHealthcare businesses are competitively well positioned. We are delivering ever-improving quality and affordable care for our customers with great consistency. We have strong assets and well-grounded fundamental discipline in a progressive culture of service and innovation. While our scale is large, our market shares are modest. We believe we have meaningful opportunities to efficiently grow for many years to come.

In Health Services, we increased combined revenues by 15% in 2010 to $25 billion. We continue to read the market and adjust and expand our service offerings to respond to the new set of challenges our customers face as healthcare continues to evolve. Our Health Services companies are working in partnership with others in the broad healthcare domain to help improve healthcare as a system, make it more modern and simpler, more connected, compliant, consistent and informed.

Our common goal is to make possible higher quality and more consistent and sustainable levels of care system performance, working locally to help improve medical outcomes and costs, patient satisfaction and optimal resource use.

In Clinical Services, ACOs and other care providers will be tasked with the total population health management. They will need to be connected, systematically informed with actionable intelligence about their patients and aligned with both their organization and with outside parties of all types around patients and overall population health.

We are cultivating distinctive capabilities in connectivity, integrated care in clinical services, data analytics and information sharing, revenue cycle management and compliance. We provide clinical services with more than 10,000 physicians and nurses on staff and an integrated pharmacy management capability. We deliver clinical services to patients directly through our clinics and collaboratively through services offered with care providers.

Before discussing the performance of the specific Health Services businesses units, as we announced earlier today, we will divest our Phase II and III Clinical Trial business for cash. Our results include $200 million in goodwill impairment and business-line disposition charges. We retain the full range of commercialization, health outcomes, safety and regulatory capabilities that are distinctive in serving the life sciences markets. These leverage our distinctive competencies in data management, healthcare economics and clinical information and analytics.

Over the years, the scale requirements for the Clinical Trials business have increased, and we believe our capital and competencies are best applied in the new areas we are pursuing within Ingenix.

Returning to fourth quarter results. Ingenix revenues of $715 million increased by $179 million or 33% year-over-year, again led by our efforts serving the care provider market. Excluding the write-down I just mentioned, Ingenix earnings from operations were $101 million in the quarter, an increase of 36% year-over-year, and Ingenix reached a record earnings level of $284 million for the full year 2010.

Adjusted operating margins exceeded 14% for the quarter and 12% for the year. On a reported basis, reflecting the $200 million write-down, Ingenix earned $84 million in 2010. Excluding the Clinical Trials unit, the revenue backlog for Ingenix increased by $1 billion or 57% year-over-year to $2.8 billion, led by record sales, bookings and recent acquisitions.

OptumHealth grew revenue 6% year-over-year in 2010 and in the fourth quarter. Results were led by public sector contract awards and third-party market growth, which has been the pattern for the past couple of years. Expansion in the integrated care market and growth in financial services contributed to OptumHealth's performance.

OptumHealth's operating margins and earnings from operations of $610 million for the year and $155 million in the fourth quarter again exceeded our original expectations, due to stronger growth, better operating cost performance and more moderate health system utilization overall.

Prescription Solutions continued to grow its top line in 2010 with a 16% year-over-year revenue increase, including 13% in the quarter. Prescription Solutions returned to a more normal PBM margin levels in 2010, in contrast to the extraordinary margins earned in 2009.

Overall, our Health Services revenues and earnings performed ahead of our original 2010 forecast, and we are encouraged by the growth opportunities we see in this early stage market.

Looking forward, we now forecast approximately $100 billion in revenues for 2011. We continue to expect the consolidated medical care ratio and operating cost ratios for 2011 will be consistent with the ranges we laid out at our recent investor conference. We expect our 2011 operating cost performance will show the benefits of continued execution on our multiyear operating cost reduction program. Our outlook for net earnings of $3.50 to $3.70 per share in 2011 is unchanged from our position at the November investor conference.

The indicators coming out of fourth quarter results are virtually all favorable. We are stronger than expected in commercial risk-based businesses at year end. Fee-based businesses were strong in January, and Medicare Advantage and Part D marketing and application process for 2011 went very well. And the Health Services businesses have accelerating momentum.

However, it is early and there is much to be learned about the coming year, including the level of medical system demand, job creation and the employment environment and funding levels for public programs. 2011 will be the first year UnitedHealthcare operates under the new minimum loss ratio and rate review regulations.

We would note that The Street earnings consensus is modestly above the upper end of our outlook for the full year, and we suggest looking at first quarter margin estimates in the context of seasonal medical utilization patterns, as well as pressures from minimum loss ratio requirements as they're introduced.

We are positive about our opportunities for growth, but cautious in our 2011 margin outlook until more experience and insight is gained. We expect cash flows from operations to remain strong, but customer prepayments did accelerate nearly $400 million in cash flows forward into 2010 from 2011.

We believe it is appropriate to take a moderated view of the positive trends, gain some visibility on the interplay of all these items over the first quarter and first half of the year and make adjustments on our outlook, if needed, as we go forward.

We expect to continue to be disciplined in our allocations of capital this year. We have historically returned to substantial portion of our net earnings to shareholders through share repurchase and now dividends. Together, this has averaged more than 80% of our net income over the past five years.

In conclusion, we believe we are delivering very strong fundamental execution and performance, which is reflected in growth, as well in physician and consumer satisfaction and in customer retention. We recognize health reform as an effort to respond to underlying and long-standing challenges in the healthcare system, and we are committed to move aggressively to address those issues. The next wave of growth opportunities will come to those who fundamentally help make the healthcare system work better, in a more sustainable way, for everyone. We are opportunistic as we enter 2011 and begin to prepare for continued growth in 2012 and beyond.

We're interested in your questions this morning. As usual, there will be one question per person, so we can speak with as many of you as possible. And I will now turn this call back to the moderator for your questions and I thank you for joining us.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Doug Simpson with Morgan Stanley.

Doug Simpson - Morgan Stanley

So could you just talk about the seasonality impact of the minimum MLRs? How is this going to work mechanically with accruals for rebates as the year progresses? Should we think about you sort of accruing on a run rate basis as we move throughout the year? Or is it kind of we see where we stand in September, October and then the accruals are larger in the second half? Just how is that going to work? And how does that impact seasonality versus years past?

Stephen Hemsley

I think that is a perfect one for Dan Schumacher from UnitedHealthcare.

Dan Schumacher

So with respect to the rebate provisioning, the way that we'll do that at the end of the first quarter will make a full year estimate of our performance, go through the calculations of what any anticipated rebates might be and then we would book 25% of that, obviously, in the first quarter. And then step into the second quarter, go through the same exercise to estimate our full year results. And again look to book 25% of that in the second quarter and make any true-up adjustments that would relate to the first quarter.

Doug Simpson - Morgan Stanley

And is that a number that you'll break out each quarter for us?

Dan Schumacher

No, it’ll be an offset to premium on the income statement and it'll be included in other policy liabilities on the balance sheet.

Operator

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

Matthew Borsch - Goldman Sachs Group Inc.

My question is just about your early read on the 2011 enrollment results. Any detail you can give on national accounts and other segments, including Medicare Advantage?

Gail Boudreaux

Gail Boudreaux. First of all, I think we're really pleased with the momentum that we've seen in our overall enrollment on the Commercial businesses coming off of 2010. You saw in our results finishing this year that we had strong growth in both the Risk business and the Self-Funded business. It's still early in January as we -- in the third week of January, but we feel good about our enrollment. We think we had a very strong enrollment, particularly as we look at the Fee-Based business. The guidance we gave you at the investor conference, we're feeling confident about that and we'll be at the upper end of that range, if not slightly above it. Part of that is we had very strong customer retention this year, as Steve mentioned in his opening comments. I think a very good open enrollment, our service results are really a strength for us, and we've had an opportunity to really demonstrate our ability and manage medical costs for our customers. So all of those pieces have contributed to what we think is a very strong open enrollment. And we'll know more as we get through this month and have our final take.

Matthew Borsch - Goldman Sachs Group Inc.

Also on Medicare Advantage, can you comment on that?

Tom Paul

Sure, Matt. This is Tom Paul. And as Gail said on the Commercial side, we also had a very solid start to the selling year for Medicare Advantage and quite frankly across our whole Medicare portfolio. This was driven, similar to what Gail said, to both new sales as well as member retention that we saw for the January 1 effectives. And contributing to that was a really strong year-over-year improvement in performance by our both internal and external sales. So based on what we've seen from our January effectives and the momentum we're building for the remaining 11 months of selling for the Medicare products, we would expect our Medicare Advantage and Medicare supplement growth to be, again, at the high end of the range that we presented at the investor conference. I want to spend a little bit of time just on Part D as well. We had significant challenges going into the year with the market consolidation and fewer regions that we would be participating in below the regional benchmark. But our market response was really quite strong. And as a result, we now expect our PDP stand-alone performance will be positive growth in 2011, and as we learn more in the coming months as to how that plays out with CMS, we’ll give further guidance.

Matthew Borsch - Goldman Sachs Group Inc.

I would just ask on what you're seeing in terms of the pricing environment. And do you think it remains disciplined to the same extent as you are now entering 2011?

Gail Boudreaux

Matt, based on your question, it's still a very competitive market and we have, as we've talked about I think, continued to see some firming as people take into impact the medical loss ratio minimums, as well as some of the coverage expansion provisions. So it's beginning to firm. It does vary by market and market segment but on balance, I think it remains fairly rational and very consistent.

Operator

Your next question comes from the line of Josh Raskin with Barclays.

Joshua Raskin - Barclays Capital

Just turning to Medicaid in terms of the expectations for membership. And then, maybe if you could talk a little bit about what you're seeing in terms of state budget pressures and the rolling off of that map? Obviously, there was some news around the Texas budget. And maybe you can help us understand what is the -- when these budgets come out and there's this perceived savings from Medicaid managed care, maybe you could help us understand exactly what your interpretation of that is.

Jack Larsen

But first, your question was what we're expecting around Medicaid membership for the next year? I think our guidance back in November was in the 225,000 to 300,000 range, made up principally by really same-store organic growth in existing markets. We really don't see a lot of new program implementations coming onboard for 2011. And that organic growth is fairly comparable to what we saw in 2010. Maybe switching over to your question about Texas. Texas budget work and then also perhaps rates and generally, did see that announcement from Texas a day or two ago. And my understanding is that it's a preliminary budget proposed by the house, and no doubt it will go through sort of multiple modifications as other budgets are introduced, and then ultimately, the governor will make his proposals sometime in February. The thing to keep in mind is that for states, when there is a fee rate schedule reduction flowing to providers, for the most part plans’ reimbursement rates are tied to those fee schedule. So while it's not a perfect 1:1 correlation, by and large, you'd see rate setting adjustments as well as medical cost adjustments. And keep in mind, all of that is underpinned by actuarial soundness for these plans. And then, your question was sort of generally, the rate environment?

Joshua Raskin - Barclays Capital

There's a proposed $1 billion of savings from Medicaid managed care and taxes, and I guess I was hoping for a little bit better understanding. My guess is that's not a reduction in rates in terms of the commensurate change with the provider fee schedule, rather that has something to do with the expansion of programs, and things like that. I guess my question was are you seeing rate reductions beyond what you would see in the fee schedules that would equate to that level of savings?

Jack Larsen

The Texas RFPs, we're really expecting the final RFP here in the next few weeks. So the $1 billion savings that you quoted I think was specifically to the provider fee-rate reduction being discussed in the budget. I don't know if that includes the proposed managed-care savings inside of proposed RFPs. Just don't know that fact.

Operator

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

Justin Lake - UBS Investment Bank

Just I have a quick follow-up for Gail on pricing. Given your previous experience in the not-for-profit blue world and the rebounding margins and capital levels we've seen there, I’d be interested in hearing your thoughts on if and when we might see the blues return to a more aggressive pricing posture. And specifically how the impact of things like MLR floors and the 2014 reform uncertainty might change the typical pricing cyclicality we've seen in the Commercial segment of over, let's say, the last 10 years.

Stephen Hemsley

We will respond to that, Justin, but we're not going to really talk much about what competitors do and so forth, other than in the most general terms.

Gail Boudreaux

Just following up on Steve's point. My comments around pricing, I can't comment on what they're going to do in the future. But what we've seen is then a very rational approach to understanding and estimating their costs and pricing to that view. So, again, it's a competitive market. We have not seen kind of irrational behavior that you're quoting. In terms of how we price going forward, we have, as I described at the investor conference, historically priced and always will price for our forward view of cost. And we take a very disciplined approach at both the bottoms-up and a centralized overview, looking at the real underlying drivers of cost, consumer behavior and the dynamics in the provider market. I don't see that changing. That's one of the fundamental components of it. We certainly take into account our overall pricing position, and we're trying to balance both growth and affordability to make sure that we can hit the right part of precision around this. So as we go into 2011, our approach has stayed fundamentally the same, and I would expect us to continue to do that. I do think we are very well positioned relative to others because of the data that we have and our ability to manage that both at the market level as well as our central controls. So we feel very well positioned around how we approach pricing.

Operator

Your next question comes from the line of Tom Carroll with Stifel.

Thomas Carroll

There's been a lot of discussion recently about CMS potentially increasing its oversight of the Medicare Advantage world. And I wonder if you could offer some further opinion on this and if you think that CMS will be more active in the current year and coming years.

Stephen Hemsley

I think Tom Paul is probably the best to at least offer a first response.

Tom Paul

I think what we've noticed is a change over the past year or so with our relationship with CMS and their oversight. And I think one is I think we share a common view of the Medicare marketplace and wanting to provide stable, affordable and solid benefits to Medicare eligibles. And as a result of doing that, there is always this level of oversight and exchange of information between our organization and CMS to ensure that we're delivering on those commitments. I quite frankly don't see that changing over the next year or so but would say that starting in 2012, we would be implementing the new impact to Medicare Advantage as a result of the health reform law. And so, we will be working with, and dialoguing with, CMS on the implications of those new changes and the best way to implement them to deliver on those shared commitments around stability and providing good affordable benefits to Medicare beneficiaries.

Operator

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

Kevin Fischbeck - BofA Merrill Lynch

I wanted to follow up on an earlier question about kind of the accounting around minimum MLR. I know that one of your competitors changed their accounting for how they allocated G&A early last year. I wanted to get a sense of whether you are going to be doing any of that for 2011. And if not, how comparable your guidance for commercial MLR or AD37 [ph] is to how it might be calculated under the actual MLR provision, any guesses we would have to make to kind of get an apples-to-apples number?

Stephen Hemsley

I think we have done it under what we believe the provisions to be. But, Dan, you want to come back to that?

Dan Schumacher

Sure. Kevin, in terms of our financials and how we state them today, we will not be making any changes in terms of how we classify things, so you can expect that to be consistent over time. And then obviously, we start with our financials and start to go through the adjustments required to get to the ultimate calculation to determine the rebates. And we'll do that and go to the course of the filing effort on an annual basis.

Kevin Fischbeck - BofA Merrill Lynch

But I guess, historically, you think about MLR as premiums. And I guess under the new definition, its premiums minus taxes, including income taxes. Are you using your historical definition for MLR in that scenario? Or are you using it under the definition of premiums minus taxes?

Dan Schumacher

We would start with our premium as we reported in our financials today, and then we would make the adjustments under the calculations. So take out the things that you started to mention around taxes, et cetera.

Kevin Fischbeck - BofA Merrill Lynch

So your guidance is under the old methodology, but obviously, when you think about rebates, you make the other adjustments.

Dan Schumacher

Correct.

Stephen Hemsley

I think maybe the simplest way to say it is, is that our financial architecture and so forth remains the same. We will have to go through what I will describe as regulatorily defined determinations as to what our MLR rebate position might be. And then, we will book that the way Dan described it in the first question. So I think we have to go through our regulatory process, but our financials will stay as we have presented them.

Operator

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

John Rex - JP Morgan Chase & Co

I wanted to come back to the Senior business. So in particular, kind of on the rather mundane topic of risk adjusters. So couple things here. I'm not looking for you to tell me what your '07 error rates are, even though I’d love that. What I'm looking for is something a little more forward here. And that would be can you tell us how processes may have changed over the years since '06, '07 in terms of how you may have created incentive structures mechanism such that medical records would more accurately reflect what was done in the office, since you're kind of being held accountable for what's getting recorded at the physician level. And is there a reason to think, or a way you've been able to gauge how that accuracy encoding might have improved at that level?

Tom Paul

Sure, John. This is Tom. So since the introduction of the risk adjustment system within the Medicare Advantage program, we have worked with our providers and with the systems in order to continually accurately and reflect the diagnosis within the medical record chart, which is somewhat the basis of the risk-adjustment system that currently exists for the Medicare Advantage program. We continually work with providers and organizations like Ingenix on ensuring that we have accuracy in the way diagnoses are recorded in the medical records, and on a year-over-year basis, continue to see improvements in those accuracy rates. The challenge here is as we look at the new coding methodology that is coming out from CMS, that methodology may change based on the outcomes of what they have proposed, and so we're working with them now to kind of look at how the current process is reflected in their methodology and how to make the system most reflective of a patient's diagnosis and their risk adjusters going forward.

John Rex - JP Morgan Chase & Co

And do you have a quantitative measure as to how accuracy has changed or improved over the last three, four years?

Tom Paul

I can't say a quantity. All I can say is that there has been changes in the accuracy of our coding of the risk adjusters.

John Rex - JP Morgan Chase & Co

And no order of magnitude even there.

Tom Paul

No.

Operator

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

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

Just to follow-up on the last question on Medicare audits, do you expect that the risk audit methodology that's been put out will be implemented eventually on a company-by-company basis? So will this likely impact the 2012 rate settings for the industry as a whole?

Tom Paul

This is Tom again. It's difficult to predict what the outcomes will be of their new proposed methodology. Again, just as a reminder, comments from organizations are not due until tomorrow, so we're still really in a comment phase. Whereas I can comment is, in their proposed methodology they do state that they will not audit every organization every year, but instead select a number of plans to be audited every year. And so I guess to answer to your question, it will not be 100% of the plans on a yearly basis. It will just be a subset of them.

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

Another follow-up is on the cost trend, the 7.5% outlook that you put out for 2011. As you're looking at your claims experience for the fourth quarter and a little bit in the first quarter of 2011, is the detail in there giving you any color on -- all of the favorable reserves, are they coming from Commercial only or are they coming from the other Government segments as well? And then, what about the near-term reform provisions, any color on the fourth quarter claims experience? This was implemented in late September.

Stephen Hemsley

Well, I think in the first one, I think I could perhaps respond by -- there has been a general experience across-the-board, across all of the benefit markets about a lower demand on health services. And as a result, I would say that the -- to answer your first question is it's broad-based across all markets. I'm not sure I understood the second question. Ana, could you come back to it?

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

Yes. The near-term reform provisions on the Patient’s Bill of Rights, all the preventive coverage, the prerequisites, et cetera -- you have four months almost now of claims experience. Was this in line with your expectations? Or is this coming in more favorable? Is there a reason for you to believe that you still don't have adequate information to make a forward forecast for full year 2011?

Stephen Hemsley

Well, it is a very short period of time. And when you think about how we establish estimates and trends and patterns. But Dan, do you want to give them a reaction?

Dan Schumacher

I think your point is exactly right, Steve, around the timing of the renewals, obviously, we've got less experience. And ‘11 obviously brings on a lot more folks with that coverage expansion. But from this distance, it looks like our estimates of those impacts are as we would expect.

Stephen Hemsley

Pretty much consistent.

Operator

Your next question comes from the line of Christine Arnold with Cowen and Company.

Christine Arnold - Cowen and Company, LLC

On Medicare Advantage and Medicaid, I'm looking at what I think is about an 81.5% MLR in both of those businesses. First of all, am I in the ballpark? And how much of an increase in those MLRs is embedded in your guidance?

Stephen Hemsley

As you know, Christine, we don't really provide that level of detail, so I can't really respond to your analysis. So maybe you could frame it another way.

Christine Arnold - Cowen and Company, LLC

As you look at the Medicare Advantage and Medicaid loss ratios, wherever they are, can you give us a sense for either how much they may have benefited from factors that you don't anticipate will continue, or other things that we should be considering as we think about those businesses going forward?

Stephen Hemsley

Dan, do you want to respond to it?

Dan Schumacher

Sure. Christine, maybe I'll tackle it in the context of earnings. As you look across the benefits landscape, we do expect earnings to be down across each of those businesses, and really, it relates to the expectation of more normal utilization, both the flu and more broadly, but then that also the high favorable development that we experienced in 2010 that applied to each of those businesses as well.

Christine Arnold - Cowen and Company, LLC

And you're still not breaking that out by any business line?

Dan Schumacher

Correct.

Operator

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

Scott Fidel - Deutsche Bank AG

Just had a question on the exchanges. I know it's early here, but just interested in your discussions with employers at this point in terms of how much interest you're seeing amongst them, in terms of potentially migrating over to the exchanges in ‘14 for the smaller groups and I guess ‘17 for the larger groups. And essentially the crux of the question Is how much risk do you think there is that we could see more accelerated crowd-out of the employer-sponsored market with the introduction of the exchanges?

Gail Boudreaux

Scott, this is Gail Boudreaux. I think you hit the key point, which it is too early to tell what exactly is going to happen in the exchanges. There's a lot to be defined both at the federal and the state level. We have been engaged with states and we're working with HHS to share our thinking about that. To put some perspective around it, we do think that the exchanges can be a valuable mechanism because there is an opportunity if we think about expanding the market and creating transparency around the market, if it's done the right way, in advancing consumer choice and innovation. So I think there are some opportunities in the exchanges. In terms of employers' reaction, again, I believe it is too early because they are not defined at this stage. We don't believe that there will be mass movement of employers out of health insurance, so I would say until we know how the exchanges are going to work -- we have some early models in a few states, but it's really too early to tell until the rules are defined.

Operator

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

Carl McDonald - CIBC World Markets

Another question on utilizations. Based on the commercial loss ratio this quarter, even after adjusting for development, it doesn't look like the normal deductible seasonality was as prevalent. Any color there and separately anything you've experienced to date that would point to higher utilization in '11.

Dan Schumacher

In the fourth quarter, what we did see is, we did see the normal increase in our utilization related to the wear-off of our deductible pattern. And that was more than offset by the lower utilization baseline that we've really been experiencing all year, as well as then the favorable development. So that's the fourth quarter. And then as you step into 2011, the first thing that we're looking at is the flu. That was abnormally low in 2010. We're expecting that to be normal in 2011. And looking at early CDC data, as well as looking at our early pharmacy data, we would suggest that it is going to be normal.

Operator

And your next question comes from the line of Charles Boorady with Crédit Suisse.

Charles Boorady - Crédit Suisse AG

As we're approaching the end of the comment period for minimum loss ratio regs, do you anticipate any changes to those regs being passable? And can you tell us here what you're baking in your in 2011 guidance for the negative impact of the minimum MLR regs?

Dan Schumacher

Charles, we're not going to, at this point, going to speculate on what we think the changes may or may not be coming out of the comment period. In terms of our guidance, we have considered the interim final regulation that came out in the fourth quarter, and we've done our best estimates under that guidance and incorporated it into our earnings outlook.

Charles Boorady - Crédit Suisse AG

Anyway, I'm just asking for a quantification I guess on that. And maybe another way to answer it is, if you do get waivers on individuals, what the impact would be to your EPS of that.

Dan Schumacher

I think on the individual side, we certainly are aware of more than a dozen states that are looking at perhaps pursuing a waiver. And we've been supplying information to them to help support and inform their decisions around it. At this point, what we've baked into our guidance is the assumption that there will not be any waivers granted, and obviously to the extent that some of the states actually do get a waiver, that could provide some opportunity for improvement on our rebate assumption.

Charles Boorady - Crédit Suisse AG

How much improvement? I guess I'm trying to quantify...

Dan Schumacher

We didn't quantify either that at the investor conference. And I don't think it's productive to quantify what is theoretical estimate at this point in time, so we haven't been closing in on that number. So all I think we can say is, is that our guidance, as we put them out at the investor conference has been considered as these regulations have evolved, haven't changed our outlook at all from what we gave at the investor conference. We assume that these regulations will be in place in all markets and at all levels. And there would be some relief if, in fact, there are waivers in certain states that would vary dramatically by the state and what our concentrations might be. So really, I think we really can't offer any guidance at this point in time on that.

Operator

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

Peter Costa - Wells Fargo Securities, LLC

Can you talk about what you've done with the broker fees going forward? And contrast that with what some of your competitors have talked about doing with broker fees. And so how are your fees been received right now compared to the competitors? And then also tell me, if you would, the impact that, that’s likely to have on your SG&A and perhaps your premium line?

Gail Boudreaux

Peter, let me start first talking a little bit about brokers, because there has been a lot of discussion about them in their role in helping consumers. We believe that brokers still have an important role, and that this is a complicated market. I want to answer your question, though, in sort of three buckets. The first is the individual market. As we talked about I think in a couple of calls, we did notify our distribution partners back in the summer that we're going to make changes to their commission schedules. In November, we provided them with the specific revised commissions. What we ended up doing is we lowered the total level of commission over the lifetime of the policy. In the group market, we have a fairly routine process for evaluating our commission level by markets, by products, et cetera. And as part of that, several years ago in the small business market, we moved to a per employee per month commission. Many of the changes you're seeing or hearing about in the marketplace from our competitors are really catching up to that methodology. So in that market, while we always evaluate by market, we don't see any fundamental changes in what's happening across our book of business. In the large group market, we have communicated to our distribution partners that we're going to transition away from our commission model, and we are committed to making that a smooth transition, again, going back to they are an important part of the process and consumers and employers rely on them. To the extent that our customers want to make arrangements with their existing brokers to pay them a service fee, we're going to help transition that and help administer that with them. In terms of impact, we see this really as a 2012 item.

Operator

Your next question comes from the line of Dave Windley with Jefferies & Company.

David Windley - Jefferies & Company, Inc.

Where do you believe cost trend has ended up for 2010? Are you reserving at that level or still relatively conservatively postured against that level? And kind of getting that, even though you don't guide, would you expect that you would see positive prior-period development in '11 from '10?

Stephen Hemsley

Dan, you want to start?

Dan Schumacher

Sure. Dave, in terms of the cost trend, I think at the investor conference, we'd indicated that we thought 2010 would likely land somewhere in the 6.5% plus or minus 50 basis points range, and right now, we see that at around 6%. So it's coming in a little bit better than we thought. And in terms of our reserve determinations at the end of the year, you know that we pick to our best estimates based on all the information that we have in front of us, and that process has not changed.

David Windley - Jefferies & Company, Inc.

And just to confirm, if you were to have positive development from '10 in '11, you would view that as not contributing to rebate requirements for '11 in the Commercial business. Is that correct?

Dan Schumacher

That would be correct, to the extent that it's in the first 90 days.

Operator

Your next question comes from the line of Kimberly Purvis with Cross Current Research.

Kimberly Purvis

Healthcare quality expenses are allowed to be included in the medical expense calculations for purposes of the MLR requirement. Can you give us any color on what you are expecting for your add-backs? Can you give us an indication of perhaps percent of premium revenue, maybe percent of your SG&A expenses? How can we look at that?

Stephen Hemsley

I appreciate the interest around this subject, but these are new areas. These regulations are not even final, and we're kind of moving into a discussion of talking about the specifics of the calculations and the elements of the calculations. And I just don't think it is productive, nor can we really engage at that level of granularity at this point in time. So I'm going to respectfully kind of see if we could move on from this, because I just think that we can't really talk about the details of this regulatory calculation in a forum like this.

Kimberly Purvis

Have you included any add-back at all in your estimates? Or have you just excluded that for now until you have more information on how you can do the calculation?

Stephen Hemsley

Well, I think the way to respond to that is to say that, I think, we are very deeply involved, and have been throughout this entire process, in the evolution of these regulations. So we are very familiar with how these regulations are moving forward. We have been making our estimates based upon our current knowledge about how the law will be applied, and we will continue to do exactly that. So there is not a lot of discretion here. These are regulatory determinations that are going to have to be made, following very clearly the regulatory law. And we will do that. And so whatever the quality elements that are part of the add-back and that determination will be exactly what they are, and we will follow the regulatory letter of the law exactly as it relates to this. And as you know from our discussions in the investor conference and so forth, this is not at excruciating levels of detail across perhaps over 400 cells where these determinations are made. So I think that is, in part, why it is really not productive to get into the details of an interim regulatory calculation. So that's why I’ll just ask that -- we will try to give you some sense of a response as this unfolds. All I can offer is, is that we have, I think, been very prudent with respect to how we have looked at this, how we have tried to position ourselves for regulations that are fluid, if you will, as we entered into 2011. And that is entered into a range in our guidance and the positioning of our guidance. And that's exactly why we made the comments in our prepared remarks that we did. So I appreciate the question and the interest, but I just don't think that we're really in a position to go further on these details.

Operator

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

Christian Rigg - Susquehanna Financial Group, LLLP

I really have a follow-up on some of the earlier accounting questions with regard to the minimum MLR and the rebates. I guess Dan's answer before makes a lot of sense to me in sort of a normal utilization environment. But I guess what I'm interested in, and if you sort of had a repeat of 2010 and 2011 where utilization remained persistently below expectations -- in a hypothetical scenario, would that at all create the potential for sort of understating the impact to the MLR provisions, sort of in the first or second quarter of the year at the expense of -- you would, at the beginning of the year, expect some reversion to your cost trend expectations. But if that did not occur, you're sort of set up in the third and fourth quarter to have to make a catch-up adjustment.

Dan Schumacher

Chris, I would just reiterate that we're going to take a full year look at it and come up with our best assessment based on our observed experience from a claims perspective and otherwise. And then we'll go through the rebate calculations. Obviously, to the extent that those factors change, our answers may change and we'll adjust accordingly.

Operator

Your next question comes from the line of Britney Abbott with Gleacher.

Joseph France - Gleacher & Company, Inc.

It's actually Joe France with just a quick question. The Supreme Court agreed on Tuesday to hear an appeal from California that could have -- it appears to make it -- could it, depending on how they rule, make it easier for states to cut Medicaid by limiting the ability of providers and beneficiaries to file lawsuits opposing them? Could you sort out what does means in practical terms? And would it actually make it easier to cut Medicaid?

Stephen Hemsley

I'm not sure that I’m as familiar with this as you are, Joe. But you're basically saying that the state is moving towards a direction of precluding legal recourse to...

Joseph France - Gleacher & Company, Inc.

No. I'm sorry. The Supreme Court agreed to hear an appeal of a case that was decided against California. I'll take this up with you off-line.

Operator

And there are actually no further questions in queue.

Stephen Hemsley

Well, then thank you. That concludes the call. To summarize, I think Unitedhealth Group delivered strong performance in 2010. That performance was based on very consistent execution in the fundamentals of our business and our focus on serving our customers. We were pleased with the depth of the leadership talent that we have across the enterprise and excited about deploying those leaders to new opportunities. We're off to a very strong start in 2011. We respect the challenges, but we're very excited about the prospects. So thank you very much for joining us today.

Operator

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.

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