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Executives

Allen Wise - Executive Chairman and Chief Executive Officer

John Stelben - Interim Chief Financial Officer and Treasurer

Drew Asher - Senior Vice President of Corporate Finance

Analysts

Joshua Raskin - Barclays Capital

Peter Costa - Wells Fargo Securities, LLC

Matthew Borsch - Goldman Sachs Group Inc.

Joshua Kaplan-Marans

John Rex - JP Morgan Chase & Co

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

Doug Simpson - Morgan Stanley

Thomas Carroll

Coventry Health Care (CVH) Q4 2010 Earnings Call February 8, 2011 8:00 AM ET

Operator

Good morning, and welcome to the Coventry Health Care's Fourth Quarter 2010 Earnings Conference Call. [Operator Instructions] Today's call will begin with opening remarks by Chief Executive Officer of Coventry Health Care, Mr. Allen Wise, after a brief forward-looking statement read by Mr. Drew Asher. Please go ahead, Drew.

Drew Asher

Ladies and gentlemen, during this call, we will make forward-looking statements. Certain risks and uncertainties including those referenced in our press release and described in the company's filings with the SEC on Form 10-K for the year ended December 31, 2009, and subsequent SEC filings may materially impact those statements and could cause actual future results to differ materially from those anticipated and discussed. Allen?

Allen Wise

Good morning and thank you for your interest in Coventry Health Care. I'd like to begin with a few comments on the quarter. And as you saw this morning, we reported another strong quarter to round out 2010 at $1.01 per diluted share. I continue to be pleased with the performance of all seven core businesses and overall, the company produced an excellent earnings result and perhaps just as important, good growth as well.

In our largest core business, Commercial Risk, we grew by 108,000 members in the quarter, a little less than 90,000 from the Mercy Health Plan acquisition, which closed on October 1 and about 20,000 organically. The organic growth was widespread as we grew in almost all of our markets during the quarter. This is the third straight quarter of Commercial Risk organic membership growth. Our Medicare Advantage business grew by 31,000 members, which was largely from the Mercy acquisition, improving our footprint in Missouri and providing us with an entry into Arkansas. Medicaid Membership grew 1.3% sequentially in the quarter with the largest growth seen in our new markets in Pennsylvania and Nebraska.

With regard to our Fee business, the revenue grew sequentially. Our capital position at the end of 2010 was outstanding, with $850 million of deployable cash on hand, of which only about $100 million is earmarked for the after-tax impact of the litigation settlement previously announced. Our debt to cap is down to 27.6%, following each quarter throughout 2010.

Before I get into the important topic of the future, I think it's instructive to look back at our company's progress for the entire 2010 year. We understand that the future matters more than the past, but the focus and activities of Coventry during 2010 were focused not only on 2010 and 2011, but to position us well for the next five years. For starters, we completed two strategic health plan acquisitions that, one, added almost $1 billion in annualized revenue to the country; fortified our position in the seven state Midwestern region where we now have 1.3 million members; it improved our cost structure across four of these states; and most importantly, provided us engaged provider partners who are actively working with us to rollout new innovative collaborative models of care and products that, in our view, will position us very well for the future.

In the important area of executive recruiting and building a stronger team, you will recall from our last conference call that I’ve either hired or was in the final stages of recruiting at least three new director boards in 2010. Ken Burdick, a seasoned veteran from United Healthcare Group, started in September of 2010 and is responsible for our Medicaid Behavioral Health business and recoveries. Ken is a capable individual who will make certain that we grow our Medicaid business in a profitable way and will help in other areas of the country as well.

We have previously announced Kevin Conlin, who joined our management team on January 1 of 2011. And while we have historically had reasonably good success in attracting capable executives with payer experience, we have not had as much success in attracting capable individuals from the provider arena, and I'm speaking specifically about executives who have developed high quality, comprehensive healthcare delivery systems and understand what leaders in this area want and need from payers in the future. Kevin's recent role was as the CEO of the Via Christi System, an innovative, integrated comprehensive provider system in the Midwest. Kevin’s a high-caliber executive with the insight and experience necessary for us to forge improved provider collaboration, improve the quality of care for our members and provide attractive benefit plans through these new provider relationships.

The newest member of our senior management team is Randy Giles, who will assume the CFO role on May 1 of 2011. Many of you may remember that I conducted an extensive search for a new CFO that took the most of 2010 while John Stelben very capably filled the role on an interim basis. Randy has extensive managed care industry experience, both in health plan finance and in operational roles over the past 20 years after beginning his career with Ernst & Young. Between now and May 1, Randy will be splitting his time focusing on our Workers’ Compensation business and becoming fully oriented in our other existing six businesses until his non-compete expires on May 1 of this year.

John Stelben will continue to fill the CFO role until May 1. And after John completes assisting Randy through a transition process, which will begin on May 1, he will remain as a direct report to me and assist in three or four critical roles as we navigate our company through what is really a rapidly changing environment. John has been with Coventry for over 14 years, where he has at one time or another faithfully served in many major roles in most areas of the company. John has done that job well and will fill a key spot as we transition our company for tomorrow's opportunities.

And while I will continue my efforts to continually recruit talent to our Coventry team, I'm extremely pleased with the team that has been assembled in the past two years. We have either retained or rehired the best of our team over the past decade, along with the new executives I've just outlined.

Back to our businesses. 2010 was a very good year for the Medicaid business. We entered two new states, growing the Medicaid membership 16% organically. In Nebraska, as you will recall, we won an RFP process effective August 1, 2010, and currently serve 48,000 members. We also qualified to enter Southeastern Pennsylvania and through the auto-assignment process, we're up to 12,000 members and growing steadily.

We view Medicaid as one of our core competencies and an important part of our diversified portfolio. We're committed to growing this line of business, which has attractive growth dynamics even though we well understand the state funding pressures.

In our Commercial business, we improved our 2010 sales results and the retention process that I referred to as an opportunity when I rejoined Coventry as the CEO in early 2009. As you will recall, we spent much of 2009 retooling our process, making both our personnel changes and bringing back the appropriate level of collaboration among the many functions critical for success in Commercial business. As you’ll also recall, our Commercial Risk book shrank almost 10% in 2009.

In 2010, we have grown Commercial Risk each of the last three quarters including Q4. We expect small group sales to continue to prove growth into 2011 given the momentum we have and the cost structure and positioning of our products, which I'll address in a minute. During the last few days, we confirmed January enrollment, which was the best results in our company for January since 2003.

On the topic of our health plans, we did continue to improve our cost structure at our Health Plan businesses, which when coupled with the micro utilization tailwind, resulted in an outstanding 2010 medical loss ratio in Commercial Group, 79.2% and Medicare Advantage Coordinated Care Plan of 82.0%.

Despite Commercial Risk, minimum MLR requirements imposed in 2011 and the annual reset bid process for Medicare Advantage causing 2011 headwinds, we enter 2011 in a position of strength in these business as cost structure ultimately drives the pricing and benefit position of our products in the market. In 2010, we positioned the company for future success in two other significant areas. As we made operational improvements, we also built deployable free cash of approximately $850 million, which we expect to grow to more than $1 billion by the second half of this year. We also put significant effort in the building of pipeline relationships in the M&A space.

Future. Well, what about the future? Well, we feel that much of what we’ve accomplished in the last quarter really is about the future. In the immediate future, we have to contend with the headwinds presented by the minimum loss ratio regulation as a part of healthcare reform. John Stelben will walk you through the impacts and earnings due to our Commercial Risk MLR increases as well as other areas to bridge the 2010 results to the 2011 forecasted earnings base. It's important to note that we view 2011 as a base on which we believe we can grow in 2012 and beyond. The cost structure, the positioning of our seven core businesses has been important historically, but is even more important prospectively.

In the commercial space, we feel very good about our local base health plan model, the underpinning which has always been about low cost. Just as our customers, individuals and group find low cost products attractive in the current environment, we believe they will see an even stronger value proposition in an exchange environment where transparency and comparability are more prevalent. I think you've already seen some fallout from carriers who didn't have the proprietary competitive cost structure or the resources and know-how to tackle tomorrow's challenges. We think that this fallout will continue and be a source of growth either by acquisition or through organic growth over the next few years.

Our company's actively working on many ACO, medical home and other collaborative issues with key innovative providers in our health plan markets. In conjunction with the two health plan acquisitions, we have implemented and are working on additional, online, incentive products with a number of provider partners. We're also rolling out a new model of care in a semi-arrangement customized for each perspective ACO and/or medical home partner.

We have implemented arrangements in five markets with more in the pipeline and believe that we are uniquely positioned with our local market presence and nimbleness to be an attractive player, partner for the high-quality health systems and providers. The ultimate goal here is to create higher quality, lower-cost products, better patient outcomes with aligned incentives with provider partners to serve our members well. This is especially true in the reform environment. We are well underway and the addition of Kevin Conlin reinforces our commitment to this area.

Hopefully it's obvious that we feel the future is about providing low-cost, high-quality, well-positioned products in many markets, partnering with innovative providers and health systems to accomplish these goals. Future is about being able to see these growth opportunities in a more challenging environment. Future is about having capital and operational flexibility and be well-positioned for acquisition opportunities. It's about having a diversified set of flexible and nimble businesses that will allow us to grow profitably.

Well, now to the subject of guidance for 2011. Because a large percentage of our business is affected by minimum loss ratios, and this is the first year we're dealing with the significant complexities associated with this process, I seriously considered not providing earnings guidance for 2011 at this time. In calculating loss ratios, we're dealing with approximately 113 different cells and 21 separate legal entities, which I believe makes predicting our blended commercial Medical Loss Ratio complicated and difficult. This is all exacerbated by the fact that this is the first time through the exercise with this.

However, in the end, we decided to give it our best shot and it's our decision to provide guidance for 2011 at a range of $2.50 to $2.70 per share. John Stelben will take you through the mechanics of this range in his presentation.

Minimum loss ratio complexity aside, I believe the low cost structure that we have historically experienced will allow us to provide a more attractive benefit plan than many of our competitors, as we meet these new minimum loss ratio standards, which should yield both increased membership and profitable revenue over time.

We look forward to the future. And although we take nothing for granted, feel the positioning of our core businesses and our opportunity to grow earnings beyond 2011 is excellent.

At this time, John is going to walk you through both the quarter and the 2011 guidance. John?

John Stelben

Good morning. Our GAAP EPS for the fourth quarter is $1.01, which is comprised of core earnings of $0.96 and $0.05 related to the runout of the privacy business. For the year ended 12/31/2010, GAAP earnings are $2.97, comprised of core earnings of $3.70; Private Fee earnings of $0.45, offset by the Q2 litigation charge of a negative $1.18. Echoing Allen's comments, 2010 earnings were truly an outstanding result on many fronts and provide a strong financial and operational foundation as we head into 2011.

Our Commercial Risk business continued its strong performance across all measures and performed in line with Q4 expectations. Commercial Group Risk membership, which represents 1.45 million of our total Commercial Risk membership of 1.64 million, grew sequentially by 86,000, including 70,000 from the acquired Mercy Health Plans and organic growth of 16,000.

For 2010, total Commercial Group Risk membership grew 179,000 or 14% including the Mercy and PHS acquisitions. Excluding the acquisitions, Commercial Group Risk grew organically year-over-year by 6,000 versus a 181,000 member loss in 2009 over 2008. This outstanding year-over-year improvement growth is proof that low-cost, coupled with sales and operational execution can produce growth in a challenging environment.

Group premium yields were in line with expectations given the mix of new sales and on a same-store basis, were up 3.3% over the prior-year quarter and 4.2% year-to-date. The Commercial Group Medical Loss Ratio of 81.3% for the quarter was in line and the year-to-date reported MLR of 79.2% is an improvement of 270 basis points over the prior year.

Our view of fundamental prospective trend remains in the range of 8% to 8 1/2%. As we stated on our last call, we are well over a year into lower than historical utilization trends and while we have seen nothing to suggest an abrupt or material increase in utilization in the recent quarter, our forward view would expect utilization to increase from our 2010 experience.

Medicare's CCP loss ratio of 84.1% was slightly ahead of expectations for the quarter and for the year, 2010 loss ratio of 82% is an improvement of 490 basis points over the prior year.

Medicaid loss ratio of 85.4% was a little better than expected on lower inpatient days. 2010 GAAP loss ratio was 85.7% and excluding the new Nebraska and Pennsylvania markets, same-store 2010 loss ratio of 84.1% is an improvement of 350 basis points over 2009 and demonstrates our ability to manage patients in a challenging revenue environment.

Part D exceeded our expectations in the quarter, driven by a better than expected loss ratio and produced about $0.05 of upside in the quarter.2010 loss ratio ended up at 83.7%, a little better than our mid-80s expectation for the year. The Medicare Advantage Private Fee product, which we exited January 1, 2010, produced $0.05 in the quarter and $0.45 year-to-date, primarily due to favorable prior-period reserve development.

Total cash and investments stand at $4.06 billion. Our investment portfolio is in excellent shape and is in a net unrealized gain position of $66 million as of December 31. GAAP cash flow from operations for the quarter was $51 million. Year-to-date, core cash flow from operations, defined as GAAP cash flow less Private Fee, was $611 million or 112% of GAAP net income adjusted for Private Fee in the Q2 litigation charge. More importantly, free deployable cash at the parent was $850 million at the end of the year.

During the quarter, we completed the acquisition of Mercy Health Plans on October 1 and in late October, received a dividend of $140 million related to the Private Fee business. Days and claims payable stand at 48.6 days versus 51.7 days at the end of Q3 and 49.5 days at December 31, 2009. The decrease in DCP of 3.1 days versus prior quarter was due to a half day impact from the Mercy acquisition, 1.5 days for reduction in claims inventories as well as other timing issues.48.6 days claims payable is consistent with prior-year end and pre-2010 historical levels.

Debt-to-cap ratio now stands at 27.6%, down slightly from the prior quarter due to earnings. We did not repay any debt or repurchase any shares in the quarter.

Looking at 2010 in the rearview mirror, our core operations performed better than at any time in our history. While there were some macro tailwinds that aided financial performance, I would offer that many improvements in our business are not explained by these tailwinds. Specifically, commercial small group sales were 28% greater than the 2009 result. Same-store Commercial Group Risk membership grew slightly on an organic basis the first time in five years.

We opened two new Medicaid markets, Nebraska and Southeast PA, totaling 60,000 new members. We closed two meaningful acquisitions with outstanding houses and partners in Via Christi and Mercy, and we realized a successful runout of the Private Fee business. As listed in our press release, we are guiding 2011 GAAP EPS in the range of $2.50 to $2.70. This range represents core earnings only. It does not include any impact related to the Q2 2010 class-action charge, which is currently in the early stages of settlement, nor does it include any residual impact from final runout of Private Fee.

While core 2011 EPS guidance is down from 2010 actual results, it's important to point out that our seven core businesses are profitable and are meaningful contributors to our earnings and cash flows. With only one month behind us, there's still a great deal of uncertainty as we view 2011, and we’ve thus taken a prudent posture in our guidance assumptions. The largest decrease in core earnings year-over-year is due to the implementation of minimum MLR regulations.

Through a very detailed and technical process, we have projected our results by state, by legal entity and by block size and applied our view of forward pricing changes, medical trend, SG&A that can be allocated to medical costs, impact of taxes, credibility adjustments to project an expected outcome for 2011. As Allen mentioned earlier, we have 113 distinct, minimum MLR calculation cells.

While we have applied our best view of projected performance by all of these cells, it is not a perfect exercise by any means. As you can see in our press release, we highlighted the aggregate Commercial Group MLR degradation of just under a couple of hundred basis points plus or minus, which translates into a year-over-year negative EPS impact of approximately $0.43 at midpoint.

The small group block, which represents 37% of Group Risk membership, ran an MLR in the low-70s in 2010 and drives the lion's share of the year-over-year projected EPS impact. Our goal is to continue to grow this small group business, and we will consider the projected rebates by legal entity as one of the factors when we set price, develop benefit plans or enter into provider partnerships.

The individual block represents just about 6% of Commercial Risk revenues with the 2011 revenue range of between $330 million and $350 million. The individual MLR ran in the mid-60s during 2010. And for 2011, we expect MLR degradation of about 900 to 1,100 basis points, which translates into a year-over-year negative EPS impact at the midpoint of $0.15.

We have not included in our guidance any relief related to the state waiver process. We will update our view of this business if any waivers are ultimately approved and are implemented in a timeframe that would materially affect our 2011 outlook. We continue to evaluate where and how we will engage in the individual business to be well positioned for 2014.

The next major year-over-year item is our Part D business. As disclosed in our third quarter earnings call, we expected a material drop in membership due primarily to a forced consolidation from five products to two. Our auto-assign regions dropped by net of six from 21 to 15, resulting in a loss of 200,000 auto-assign members. As part of the consolidation, our secure product, which had approximately 325,000 members and was the number one low cost plan in 24 of 34 regions in 2010, did not meet the meaningful difference test as defined by CMS very late in the 2011 bid process. While all the secure members were mapped to our basic plan offering, approximately 150,000 of these members termed.

In addition, we lost an additional net 130,000 members from our other retail products. We project Part D membership to be around 1.1 million members, a reduction of a little over 30% or 500,000 members. We do expect loss ratios to be stable to 2010. The gross margin impact of the volume reduction is in the range of $0.32 to $0.36 year-over-year. I want to stress that Part D continues to be a core and a profitable business for us in 2011, and we are working on ways to grow this business in 2012 and beyond.

We expect the 2011 Medicare Advantage revenues in the range of $2.2 billion to $2.3 billion, with loss ratios in the mid-80s as developed in our 2011 bids. As laid out in the table in our press release, the 2011 guidance loss ratio was higher than the 2010 loss ratio of 82%, primarily due to the bid reset process. The loss ratio degradation creates a negative year-over-year EPS impact in the range of $0.25 to $0.30.

We expect 2011 Medicaid revenues to be in the range of $1.3 billion with a loss ratio in the upper-80s. We're expecting continued growth through the auto-assign process in Southeast PA during 2011. Guidance does not include any potential new market entries in 2011.

Guidance loss ratio for 2011 is a little higher than the 2010 actual result, driven by the annualization of the Nebraska and Pennsylvania market mix as well as a challenging rate environment, resulting in a stable view of Medicaid earnings for 2011.

Our fee-based businesses in total are expected to be stable to 2010. On SG&A, the midpoint of the 2011 guidance range is $2.02 billion, which is about $60 million higher than the 2010 core result. The dollar increase is primarily driven by the full year impact of the Mercy acquisition. Excluding Mercy, SG&A dollars are essentially flat year-over-year. We are making additional investments in technology and medical management to support our long-term goals to better manage medical costs, support new provider models, drive further efficiency in our back-office costs as well as be in compliance with the new healthcare reform administrative requirements.

As is our history, we'll continue to tightly manage this area and look for ways to improve the short and long-term cost structure. The midpoint of our guidance range assumes a flat diluted share count to the Q4 diluted share count level. Stated earlier, we have $850 million of deployable cash on hand to 12/31 and expect a dividend up the remainder of the capital from the private fee product of approximately $140 million during the second quarter of 2011.

We are still on track to have an excess of $1 billion of capital by mid-2011, which would be used for our deployment priorities after any necessary after-tax payments to resolve the Q2 2010 one-time litigation charge. Our priorities for deployable cash continue to be growing the business through acquisition, followed by opportunistic share repurchase and delevering.

To conclude, 2010 was an outstanding result for our company in terms of revenue growth, earnings and operational improvements and continued to build our foundation for long-term profitable growth. While healthcare reform certainly poses challenges in 2011, we believe there is a longer-term opportunity to grow profitably. Low-cost, high-quality operators should always be able to compete successfully in any environment. There's nothing fancy or magic about it, it's just getting up and outworking the other guy every day. This has been our focus for the past 15 years, and we'll continue to propel our ability to compete going forward.

We'll now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we will take the first question from Tom Carroll with Stifel.

Thomas Carroll

First of all, could you reconcile your commercial enrollment guidance of flat to down with your comment that January was the best month you've seen since 2003? Did I misinterpret that?

Allen Wise

No, you didn't and I think two comments would be in order. It's been a couple of days, really literally 48 hours that we reconciled our January enrollment, which was a bit better or maybe more than a bit better than we would have forecast a few weeks ago. Probably a continuation of the success we've had. But I think that we had good success last year doesn't mean our competitors are standing still and there won't be some pushback and we've seen that in a couple of marketplaces where they're using up some of their balance sheet to be more competitive. So we think in today's arena, with unemployment pushing 10%, to be flat at this particular time, given our very difficult 2009, is probably a mid-case prediction. So it was a bit better than we thought a couple weeks ago. So we'll take the good news.

Thomas Carroll

Secondly, how do you anticipate the accounting working for the MLR minimums when we see your first quarter of 2011?

John Stelben

Tom, this is John. I think what we're going to do is we're going to really project what we think that potential liability would be for the year. And then we would record 25% of that in Q1. So you can think about it on a straight line basis.

Operator

Now moving to a question from Doug Simpson, MSSB.

Doug Simpson - Morgan Stanley

Allen, could you just talk a little bit about how you're thinking about the balance sheet? $850 million of deployable cash. Just maybe an update on more specifically if you could the potential for M&A and how do you think about buybacks? And maybe just wrap those comments with what you're seeing in terms of the investment yields that you're getting, which are obviously pretty low at this point.

Allen Wise

I think it's pretty consistent with our comments, which is that we feel like that the opportunity to duplicate the acquisitions that we've done this year with provider partners, which yielded way more than membership. In the end, providers take care of our members. In the end, they're hiring more and more primary care physicians. And in the end, we think that more collaborative partnerships, especially in a minimum loss ratio environment to provide them help in the form of data information, administrative help, to manage those patients better and with the resulting cost structure that should be better than our competitors to gain membership is the first place that we would rather spend our capital. We think that environment, while you never can predict for certain, we think that environment is good and we think it's improving. We're extraordinarily pleased with the results of the two that we have done in terms of our future cost structure, in terms of our future relationship with high-quality delivery systems. So we prefer to do that if we can. The second piece to that is, if we can't use all the capital as the year progresses, we would consider a share repurchase and let's see how the year develops. But we'd like to buy businesses that we can make better and make us more competitive first. And it's a high-class problem after that. If we can't deploy all the capital, we’ll think about a repurchase.

Doug Simpson - Morgan Stanley

What do you think is sort of the run rate level of capital you'd want to keep at the parent, holding deal financing aside? What’s sort of the parent company liquidity target that you're running at today?

John Stelben

We typically like to have about $100 million at corporate just for normal working capital purposes.

Doug Simpson - Morgan Stanley

So if we think about the potential pipeline relative to the level of cash you have, should we put something like a 2:1 leverage on the remaining $750 million? Is that order of magnitude the right way to think about that?

Allen Wise

I guess the way I look at it we want to keep as much dry powder as we can because I absolutely believe that as this business gets tougher, and it certainly is, the revenue is harder to come by on all fronts, that people are going to opt out of the Risk business. And I'm absolutely convinced, and it’s difficult to predict the timing that we’re going to find opportunities to do what we have historically done very well, which is buy underperforming assets, make them better. And so we're going to keep as much dry powder as much as we can until that is proven wrong.

John Stelben

And, Doug, I would just add, in 2012, we have some debt maturities. And so we have flexibility there as well.

Doug Simpson - Morgan Stanley

Maybe just one question, thinking about credibility adjustments. And I apologize if you mentioned this in the early part of the call. To what extent does that factor into the forecast? How are you thinking about how they may or may not impact your business in the local market?

John Stelben

Doug, when we look at that and as I said, we have 113 calcs in the company. And so we have a view of SG&A, tax and credibility has an impact in a range of, depending on the market, of 50 to 150 basis points in the minimum MLR calculation. So we certainly consider that and factor that into our decision-making around pricing or benefit design going forward.

Operator

And now we'll take a question from Matthew Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs Group Inc.

If I could ask you about your own pricing strategy and what you're seeing from others. You made a reference to some competitors using their balance sheets to be more competitive on pricing. I'm wondering if you can give us any characterization geographically or otherwise where you might be seeing that, how widespread it is? And then secondarily on your own pricing strategy, I know last quarter you guys had spoken to reducing price in some cases proactively with regards to the MLR threshold. Could you just talk to where you are on that?

Allen Wise

Don’t take the answer out of context. When we were talking about our ability to continue growing our commercial book and why aren't we predicting off the charts. There's always going to be some pushback. Always has been. I wouldn't say that the characteristics are any different than they have been. In 20 markets there maybe two where I have some initial anecdotals. That is getting a bit tougher. So it's not widespread. I think in the end, the cost structure and the margins that we have enjoyed will be converted to more attractive benefit plans. And so I feel good long term about our ability to grow in the marketplaces. Our philosophy is if in an inexact process that we've got a lot to learn about, if our guesstimate is that if we have to air that we're going to be somewhere between 78% and 82%, our philosophy is that we would rather be a bit north of 80%. And I'd rather be closer to 82% than 76%. So it's not an exact process. What we've done in the past doesn't work for the future. But our philosophy is to price the product competitively and to share gains that we make in managing our patients with our provider partners. And to be over 80% a bit rather than writing rebate checks.

Matthew Borsch - Goldman Sachs Group Inc.

If I could ask one more on the Medicare Advantage business. I may have missed your comments on the higher loss ratio that you're expecting in M&A. Is that a process of your own calculation in the 2011 bid versus how much might it reflect the interaction between yourselves and the CMS regulators over the final bid?

Allen Wise

I think it's more a couple of things, which is that we don't expect the negative utilization trend to continue. And it's maybe abating a bit. It’s factored on that we are getting little if any rate increase. So to say that medical trend doesn’t increase, or that loss ratio doesn’t increase, the trend is zero, and we just don't believe that. It's a bit of headwinds blowing there, Matt. In terms of revenue and in terms of extraordinarily favorable utilization last year. There isn't much evidence to suggest that, that's going to continue forever and the revenues is tough. When we’re going to mitigate to that extent we can. We’re taking better care of the members. We've been working on that for a couple of years, so we'll see. It's not pessimistic, but it's not quite as rosy as it was this year than last year.

John Stelben

But I would add, Matt, that it is consistent with our overall bid expectations.

Operator

Now, we'll move to a question from Ana Gupte with Sanford Bernstein.

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

Just trying to reconcile your revenue guidance to some of the other guidance points you gave. And despite the Part D losses, which I think the street said that they’d factored in quite a bit. It seems that the Risk revenue particularly is coming in lower. And I was just trying to understand the drivers of what that is. Is it mostly enrollment? Or because of your pricing strategy possibly to MLR floors, where are you expecting your net average premium meals to come in on the book for 2011?

John Stelben

Ana, this is John. When I look at sort of Risk revenue, you take Part D out of that and you're going to have the annualization of the Mercy acquisition. So Risk revenue actually is growing nicely year-over-year, x Part D. I would tell you that in addition, another way you need to think about too is that potential rebate liability shows up on the revenue line, not the medical cost line. So there's a little pressure there.

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

And on the premium yields, you may have priced the floors in certain geographies. What was your assumption for cost trend in 2011? And where did you see it netting out at the end of the year?

John Stelben

As I stated earlier, our view of fundamental prospective trend is in the range of 8% and 8.5%. In the rearview mirror, we'd be more looking at something on a fundamental basis in the range of 6% to 7%. The difference between those two numbers is driven all by utilization across the service categories.

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

And did you finally release reserve in the fourth quarter? I may have missed this if you did. And can you give us any color on that?

John Stelben

No. Our reserving process is consistent quarter-to-quarter. There was no distinct reserve release in Q4.

Operator

And now we'll hear from John Raskin (sic) [Josh Raskin] with Barclays.

Joshua Raskin - Barclays Capital

The PDP gross margin compression that's going to knock out, I think he said $0.32 to $0.36 for next year, I guess that implies sort of a 12% margin loss. I'm just curious, is there no ability on the G&A or is that offset sort of in the other? It just seemed like a big number for the total earnings power of that 500,000 lives.

John Stelben

Josh, there is some SG&A offset in other, but there is going to be a fixed cost rub here that's creating the pressure. That's why your marginal earnings level looks higher.

Joshua Raskin - Barclays Capital

Is that strategic in the sense that you want to maintain that infrastructure for potential growth in ’12 and beyond?

John Stelben

Part of it's that, and part of it's the way we allocate overhead to our businesses.

Joshua Raskin - Barclays Capital

And that's based on revenues or something I assume is what happens.

John Stelben

It's based on a lot of things.

Joshua Raskin - Barclays Capital

Just getting back to the M&A assumption, the pressure for 2011 around the Medicare Advantage business. Just maybe walk us through sort of the bid process. Because my understanding is you guys put your bids in back in January. You guys have shown better results in M&A specifically in the second half. So I'm curious why that doesn't carry over into 2011.

John Stelben

Well at the time we set our bids last June, we had a view of the business, and we had a view of it, as Allen mentioned earlier, of where we thought trends would go. There’s certainly a bit of a mix impact from here on the Mercy acquisition. But our view going forward is that we think trends are going to increase. We really, on a same-store basis, are looking at revenue rates that are almost a point down year-over-year. There are some tailwinds this year. I think we made progress in managing patients better. But at this point, it's February 8. Until I have more visibility into how that business is performing, we're guiding to consistent with bid expectations. The risk scores that we see so far this year are consistent with our bid expectations.

Joshua Raskin - Barclays Capital

Just last clarification on your guidance, the way you developed guidance. Should we think about the process for '11 similar to the process to '10? And obviously, but I know you did a lot better and there were some sort of unexpected benefits. But should we think about '11, this guidance, as sort of a base range to grow off of?

John Stelben

I think the guidance that we’ve given is our best view today of where we think the business performs. And we'll certainly be updating you in 90 days about an updated view of that.

Operator

And now we'll move to a question from John Rex with JP Morgan.

John Rex - JP Morgan Chase & Co

So when you talk about, just taking context in your guidance for ’11, you're looking for something like around, I guess, 5% pretax margin. I just want to get your thoughts, Allen, and when you think about your current mix of business. So assuming this current book, is that where you think this mix should perform? I'm just thinking about this looking back to the years where you were running a double-digit pretax margin. Just think about what's -- is 5% the right number for this book in the years ahead, regardless of kind of some of the pushes and pulls for the '11?

Allen Wise

Don't know if I can fine-tune it, whether it's 5% or 6 1/2%. But unquestionably, because minimum loss ratios in the revenue side on government programs, both Medicare and Medicaid, our margins are diminishing. So we're all about getting a bigger book of business here and growing revenue and back to the M&A philosophy and back to returning to our basics to grow what we've got. We think we can grow what we've got. We think there’s going to be a bunch of M&A opportunities. The margins of yesterday aren't real for tomorrow.

John Rex - JP Morgan Chase & Co

So you’ve got it pegged at -- not to pin you down entirely, but you'd kind of pegged 6 1/2%, that range, 5%, 6 1/2%, as what one could do in this current book in this environment.

Allen Wise

Something in that range, yes.

John Rex - JP Morgan Chase & Co

And then maybe you could talk to -- what do you think the biggest risks are to the earnings target you put up today? I guess we could start with cost trend accelerating to 11%. But could you just kind of walk through your thought? I thought it was interesting you said you even contemplated not putting up guidance. But where would you see at this level your biggest risk factors are?

Allen Wise

I think that we have accommodated most of the risk factors in the guidance that we have given. Who would have ever, if you want to talk about risk factors, the Gunderson litigation, which we reported on in the state of Louisiana for Workers’ Comp in retrospect, this goes back to advance in 2004, that we could never reconcile with the result down there. So it's just out of left field. Don't think it was justified and it's something that you could never – I or no one else predicted over the years. But I think in terms of not being able to grow our business or losing membership or major provider -- I think that as we work through the process of cost trends, utilization, things that could -- we arrived at guidance on things on a number we know we can do. And know is a strong word. But we did not -- I don't like the guidance number and neither does my Board of Directors and neither do our shareholders. But you can't do it with a pencil, so we start with a science that John walked you through of what we know we can do and what kind of tailwinds could there be. Well, utilization could be a bit better. We could do a bit better on SG&A than the expenditures we have. We could do a bit better which is part of SG&A on both our commissions. So we think there could be some positive developments. But I don't think that this company, that I want to be part of giving guidance on things that we think. So a long way of saying, I can't anticipate anything -- risk factors that we haven't other than a litigation or a bankruptcy of the state of Illinois, which we have a large insured book of business there. But other than that, I don't have a clue.

John Rex - JP Morgan Chase & Co

And if your acquisition strategy -- looking ahead, should we expect it pretty much the same, you're biased towards Commercial Risk books or would government program enter the business -- discrete government program books be part of that also?

Allen Wise

Always the latter for sure. We spent a lot of time thinking about, talking about visiting with people. Large and small acquisitions in all three areas would definitely –- if an opportunity came on the government side, we would definitely be in the middle of that.

Operator

And now we'll hear from Peter Costa with Wells Fargo Securities.

Peter Costa - Wells Fargo Securities, LLC

Question on your Part D business. You withdrew from the Private Fee-for-Service business nationally. You offered your health plans under different brand names. Does it really make sense to have a large private Part D plan operating going forward, given the relative lack of success you had this year in retaining some of the membership given the move to two plans? Also looking at the multiples of some of those plans that sold out recently, is this a possibility that you would look to sell that operation?

Allen Wise

We didn't withdraw at all. We have five plans and we thought that we were going to get three approved right up to the last minute and CMS did not agree. So number one, in 24 of 34 regions, we had the lowest cost product. It's one that the consumers bought off of CMS’s website, and there were not brokers involved. It’s something consumers liked and served us well. And the fact that it wasn't approved was a major surprise and a major disappointment to us. We are not going there -- we've had a five-year history of growing that business and doing well, and we're not going to abandon that business. We've grown it in the past, we're going to grow it in the future. It is one of my personal initiatives and we're going to pursue the Part D business with all the resources and creativity that we can. Makes no sense at all to withdraw. We like Government business, we like the Part D business and we're going to grow it. The main thing I told you about commercial, 24 months ago, it's unacceptable to go the wrong way. We know how to do it. We got back to basics here. And so we're going to grow the Part D business.

Peter Costa - Wells Fargo Securities, LLC

Do you believe that they'll let you bring back that low cost product this year?

Allen Wise

I believe that they'll let us approve tomorrow's model that's going to be a low-cost product. It's not going to be yesterday's product, no. And it's too early to comment on our efforts and activities in that front, but we will as soon as we can.

Peter Costa - Wells Fargo Securities, LLC

What are you doing with your broker fees? And what are you seeing for the results from other health plans doing to their broker fees in the Commercial business?

Allen Wise

We're being darn careful. We know within tomorrow's arena that our SG&A including broker fees have to be less. There are some markets where we were not getting good help from the brokers, where we're direct. Iowa’s an example, that's not a new story. We've been attempting to do that for a long period of time and finally found the right combination and actually grew that business nicely. But it is a market-by-market ongoing fine-tuning and it's the only way you can explain it. There are localities where we're not going to be able to do much because our competitors aren't. And there are many competitors in the area. There are areas where we have done something and have done it successfully. But it's market-by-market and you have to be careful or you'll lose your book of business. But we're going to make progress.

Operator

And it looks like we have time for one final question. That question will come from Kevin Fischbeck with Bank of America Merrill Lynch.

Joshua Kaplan-Marans

This is actually Josh Marans in for Kevin. You spoke about the Commercial Risk enrollment coming in a little bit better than you expected a few weeks ago. Could you just quantify what the difference could be there, when we think about Q1 versus what you have in the guidance?

Allen Wise

That's what I'm going to ask my people that rent my six coaches [ph] and might borrow that when I find them in a couple of minutes here. I don't know. As recently as second week in January, the projections of the field offices were just more modest and we have only reconciled and have audited numbers for the last couple of days here. So I don't know. I guess it's a continuation of the progress that we made last year and a bit of conservatism on the projections that John got from our production people. It's a high-class problem that I can't answer right now. But not any one large account. And we've just made huge progress in some markets and it goes back to the provider model that we talked about. The first acquisition we closed in February, which is Via Christi. Through that, it's an innovative system that's totally collaborative in benefit plans and design and the cost structure. If you want a total outliner, we had very little success in the small group market in that part of the world for years. And in fact, in January of 2010, enrolled something like 23 subscribers and then a small group there, it was 460. And the numbers just kept coming in after the first of the year in some of those markets. So it's about a lot of years of work coming together and why it changed in two weeks is something we're still trying to figure out.

Joshua Kaplan-Marans

Just one question on the parent cash bridge for 2011, you spoke about $1 billion -- over $1 billion of cash that’s apparent by mid-2011. What about the full year, what do you expect in terms of total subsidiary dividends?

John Stelben

I would say that the number including the 140 for Private Fee, it's in the low $300 million. So you can think about $200 million during 2011.

Allen Wise

Thank you very much.

Operator

Ladies and gentlemen, that will conclude today's conference for today. Thank you for your participation.

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