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Executives

Mark Bertolini - Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Member of Investment & Finance Committee

Thomas Cowhey - Vice President of Investor Relations

Joseph Zubretsky - Chief Financial Officer and Senior Executive Vice President

Analysts

Joshua Raskin - Barclays Capital

Justin Lake - UBS Investment Bank

Peter Costa - Wells Fargo Securities, LLC

Carl McDonald - Citigroup Inc

Matthew Borsch - Goldman Sachs Group Inc.

Charles Boorady - Crédit Suisse AG

Scott Fidel - Deutsche Bank AG

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

John Rex - JP Morgan Chase & Co

Christine Arnold - Cowen and Company, LLC

Kevin Fischbeck - BofA Merrill Lynch

Doug Simpson - Morgan Stanley

Aetna (AET) Q2 2011 Earnings Call July 27, 2011 8:30 AM ET

Operator

Good morning. My name is Trisha, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the Aetna Second Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to Mr. Tom Cowhey, Vice President of Investor Relations. Mr. Cowhey, please go ahead.

Thomas Cowhey

Good morning, and thank you for joining Aetna's Second Quarter 2011 Earnings Call and Webcast. This is Tom Cowhey, Vice President of Investor Relations for Aetna. And with me this morning are Aetna's Chairman, Chief Executive Officer and President, Mark Bertolini; and Senior Executive Vice President and Chief Financial Officer, Joe Zubretsky. Following their prepared remarks, we will respond to your questions.

During this call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in Aetna's 2010 Form 10-K and our second quarter 2011 Form 10-Q when filed with the SEC. Pursuant to SEC Regulation G, we have provided reconciliations of metrics related to the company's performance that are non-GAAP measures in our second quarter 2011 financial supplement and our 2011 guidance summary. These reconciliations are available on the Investor Information portion of aetna.com.

Also, as you know, Regulation FD limits our ability to respond to certain inquiries from investors and analysts in nonpublic forums, so we invite you to ask all questions of a material nature on this call.

With that, I will turn the call over to Mark Bertolini. Mark?

Mark Bertolini

Good morning. Thank you, Tom, and thank you all for joining us today. This morning, we reported second quarter operating earnings per share of $1.35, a 29% increase over 2010. These results reflect strong operating fundamentals across all aspects of our business, including disciplined pricing and medical cost management and strong cash flow generation. Our second quarter 2011 Commercial medical benefit ratio was 77.9%, a result of disciplined execution of our pricing and medical cost management strategies and lower-than-projected utilization.

The Medicare and Medicaid businesses also performed well in the quarter. The second quarter 2011 Medicare medical benefit ratio was 84.6%, with performance driven by our group Medicare results, while the Medicaid business added 30,000 members in the quarter.

On a year-to-date basis, we have reported operating earnings of $2.78 per share and an 11% pretax operating margin, exceptional results that were partially driven by declining utilization and the medical cost trends. We continue to target high single-digit pretax operating margins and our pricing to reflect our forward view of medical cost trends.

Based on these results and our outlook for the balance of the year, we have increased our full-year 2011 operating EPS projection to $4.60 to $4.70. We project dividends from subsidiaries for 2011 will increase to $2.6 billion, up from our previous projection of $2.4 billion.

We further project a full-year outlook of approximately 18.2 million medical members consistent with our second quarter medical membership. The change in membership from our previous guidance reflects both a decline in our core business, driven primarily by Commercial ASC membership and Prodigy delivering fewer members than we have previously estimated. In a few moments, Joe will provide more detailed results on the quarter and will review our updated 2011 guidance.

First, I would like to discuss our progress in executing against our strategic priorities in the second quarter. At our Investor Day, we discussed the 3 dimensions of our strategy to create shareholder value: advancing the core business, emerging business growth and deploying capital effectively.

I will start my comments with our core business, and will provide an update on the 2012 national account selling season and describe the outlook for our Medicare business. Our national accounts franchise is an important part of our core business, serving over 8.8 million medical members and 2/3 of the Fortune 100. The cornerstone of our value proposition and our historical success has been our quality and total cost approach, which we believe delivers superior long-term value. However, current economic conditions continue to drive some plan sponsors to favor unit cost discounts over total value.

Our current projection is that the first quarter 2012 national account membership will decrease by approximately 500,000 Commercial ASC members. Our projected membership decline is driven by the lapse of 2 specific accounts, which together account for approximately 300,000 members. Our expected change in 2012 national accounts ASC membership is disappointing, and our senior leadership is actively engaged in reversing this unfavorable trend. We are committed to strengthening our provider contracts with a specific focus on our targeted growth markets to meet the needs of our customers and improve our performance.

While we must improve our discount position and our performance, we continue to believe that the long-term value we offer to our customers is superior to our competition. The strength of our value proposition is validated by the improving performance of our large group commercial risk business, where we priced the benefits of our solutions into competitive marketplace premiums. In fact, we projected the decline in 2012 national accounts ASC membership will be partially offset by the growth in other businesses, including Medicare Advantage and large group commercial risk. These businesses are currently showing sales traction that we expect to continue into 2012.

Moving on to Medicare. We are very pleased with the progress of our Medicare business made in the second quarter. The lifting of CMS sanctions in June and the pending acquisition of Genworth's Medicare supplement business will advance our Medicare platform. Aetna is focused on developing solutions that help retirees manage their health and employers manage their expenses, both growing challenges as the baby boomers enter the Medicare program. We are confident that our open enrollment season will be a success and expect robust membership growth from our Medicare business in the first quarter of 2012.

Beyond our core business, the second dimension of our strategy is to create shareholder value in our emerging businesses. We are developing new models of working with providers, and Aetna's accountable care solutions business made strong progress during the second quarter. Combining the capabilities of Medicity and ActiveHealth with Aetna's core health plan infrastructure, we believe we have the technology, resources and capabilities to be a leader in this emerging business.

Our main objectives are: first, to develop a lower medical cost structure through innovative contracting; second, to increase membership; and third, to generate incremental fee revenues by managing the infrastructure necessary for accountable care organizations. In the first quarter, we announced an initiative with Carilion Clinic, the largest health care provider in Southwest Virginia. As a result of this initiative, Aetna has already added 18,000 ASC members, and starting next year, we plan to jointly launch new products in the Commercial, Medicare and Medicaid markets.

In addition, we have signed agreements with 2 other regional health systems, in each case, transforming the transactional relationship that typically exists between insurers and health systems. We are excited to be working with Emory Healthcare in Atlanta and Heartland Health in St. Joseph, Missouri. Our collaborative efforts with these marquee health systems will help identify gaps in care and improve outcomes, while introducing collaborative payment models designed to improve health care quality.

Our current pipeline contains dozens of similar provider opportunities, and we expect the pace of announcements to gain momentum in the coming quarters. Over time, we see the opportunity to evolve this emerging business, to change the dynamics of provider contracting and develop affordable health plan options focused on quality and cost.

During the quarter, Medicity continued to expand its own customer base while supporting the growth of our accountable care solutions business. We are pleased that Medicity was selected as the vendor for the Mississippi and Ohio's State Health Information Exchanges in May. These relationships will enhance Medicity's growing presence in the state marketplace. Medicity has a robust sales pipeline of potential state and private health system clients, a growing contract backlog approaching $200 million and an increasing number of end users.

Our strategy is to grow our footprint in this space and to deliver clinical and administrative content through Medicity's installed base of health information exchanges. For example, Medicity has developed and is beginning to distribute a suite of applications that are certified as being compliant with the federal meaningful use standards. Medicity's application development expertise and patented distribution technologies are great examples of how the company combines content and connectivity.

At Aetna, we are excited about our role in promoting health information technology because we believe it has tremendous potential to improve the quality of health care and to make health care more affordable. We continue to build a portfolio of businesses that simultaneously generate high growth fee revenues and improve the performance of our health plan businesses.

With respect to our international business, our product launches in China early this year have demonstrated initial success. Further in June, we entered the market in India through the very small but strategically important acquisition of Indian Health Organization, a fast-growing medical discount card provider, serving approximately 80,000 individuals in 18 major cities. Indian Health Organization is just one of the innovative ventures Aetna is pursuing globally to expand our footprint and develop new business models.

With respect to the third component of our strategy, deploying capital to enhance shareholder value. In the second quarter, we closed 1 transaction and announced another, both will enhance our capabilities and strengthen our Commercial business. First, we closed our acquisition of Prodigy at the end of June, and we are excited to have a lower-cost administrative platform to offer customers that are primarily price-focused. Prodigy's highly-customized offering addresses a portion of the self-funded market that we size at 27 million lives. The combination of organic growth potential and cost synergies makes this an exciting acquisition for our customers and our shareholders.

In addition, last week, we announced an agreement to acquire PayFlex, an administrator of FSAs, HSAs and other accounts that support consumer-based health plan designs. PayFlex offers a flexible low-cost solution that serves numerous Fortune 500 companies. PayFlex will significantly strengthen our existing HSA administration offerings and provide additional capabilities to support growth within our core Commercial business.

With the purchase of Medicity in January, the closing of our Prodigy Health acquisition in June and our pending transactions in 2011, we will have deployed $1.6 billion to strengthen the enterprise and fuel future growth. Each of these acquisitions is consistent with our long-term strategy. Aetna continues to approach acquisitions in a disciplined and responsible manner. We are executing against predetermined criteria to add numbers, fill capability gaps and diversify our business.

Finally, a quick comment about Health Care Reform. We continue to work closely with our federal and state partners on behalf of our members, customers and shareholders as we implement the many facets of this new law. In this new environment, we continue to see opportunities emerge, most notably the collaborative provider business models and health information technology connectivity solutions I mentioned earlier. We look forward to demonstrating our progress on these potentially transformative initiatives.

In summary, I am pleased with our second quarter and year-to-date performance. I am confident in our strategic direction and our updated full-year 2011 operating earnings per share projection of $4.60 to $4.70. I would like to thank all of our employees for their dedication in meeting the needs of our customers by focusing on sound fundamentals, creating new approaches to satisfying customers and generating significant excess capital. We believe that we can continue to create value for our customers and shareholders.

I will now turn the call over to Joe Zubretsky to provide insight into our second quarter results and our full-year 2011 outlook. Joe?

Joseph Zubretsky

Thanks, Mark, and good morning, everyone. Earlier today, we reported second quarter operating earnings per share of $1.35, an increase of 29% compared to the prior year quarter. On a year-to-date basis, our operating earnings per share is $2.78 or $2.46, excluding prior year reserve development. This year-to-date result reflects strong performance with respect to underwriting margins across all product lines.

In the quarter, operating earnings were $523 million, representing a year-over-year increase of 16%. This increase reflects higher commercial underwriting margins for the improved underlying performance, partially offset by lower Commercial Insured membership.

Second quarter highlights include a Commercial medical benefit ratio of 81.2%, excluding prior period reserve development; favorable development of $188 million in the Commercial, Medicare and Medicaid product lines, primarily off of first quarter incurred medical costs, which reflects the strong results for the 2011 underwriting year; and excellent parent company capital generation with approximately $550 million of subsidiary dividends to the parent in the quarter.

The second quarter 2011 pretax operating margin was 10.7%, a 150-basis point improvement over 2010, due primarily to disciplined execution of our pricing and medical cost management strategies and lower-than-projected utilization. We ended the quarter with 18.2 million medical members, an increase of 447,000 from the end of the first quarter. This increase reflects the addition of 523,000 members from the acquisition of Prodigy, offset by an organic decrease of 76,000 members. The Prodigy membership number is lower than our previously announced estimate, and this revision has no impact on its historical and projected financial performance as Prodigy's revenues are based on employee lives rather than members.

Excluding the acquisition of Prodigy, Aetna's medical membership declined by 76,000 from the first quarter. Commercial ASC membership decreased by 66,000 members. Commercial Insured membership decreased by 38,000 members, primarily in our small group business. We have taken pricing actions that we believe will stabilize the membership in this business over the remainder of the year. Medicare membership was down 2,000 members in the quarter, essentially flat despite the impact of CMS sanctions.

We also added 30,000 Medicaid members in the quarter, as membership grew throughout our footprint led by programs in Texas, Florida and Pennsylvania. Also in the quarter, the Illinois AABD program started enrolling members. Second quarter Pharmacy membership decreased by approximately 79,000 members, excluding the acquisition of Prodigy. Prodigy added 292,000 Commercial Pharmacy members, which drives a key synergy of this acquisition.

Second quarter 2011 revenue declined 2.1% year-over-year to $8.3 billion, primarily due to a decline in Health Care premium. This decline included a net decrease in Commercial premium of 2% due to volume declining by 7%, partially offset by a 5% increase in premium yields resulting from a 7% increase in rates, offset by mix changes related to customer market segment, product and geography.

Health Care premium also reflected a 9.9% decrease in Medicare premium due to lower volume and a 32% increase in Medicaid premium that is related primarily to membership gains. Health Care fees and other revenue were $869 million in the second quarter, an increase of $25 million year-over-year. Health Care fields increased due partially to increased Pharmacy revenues from our new CVS Caremark relationship and were partially offset by a decline in volume due to the membership decrease.

Our second quarter total Medical benefit ratio was 79.7%, including $188 million before tax of favorable prior period reserve development. Second quarter development included $23 million related to prior year medical costs, with the remainder attributable to the first quarter 2011. This favorable development was comprised of $167 million in Commercial, $18 million in Medicare and $3 million in Medicaid. The Commercial MBR was 77.9% or 81.2% excluding favorable development. Our Commercial MBR is also influenced by an accrual for minimum medical loss ratio rebates. We have developed a sophisticated internal infrastructure to monitor and project the impact of this new regulation.

Based on our full-year projections, we have accrued a prudent estimate representing 50% of our estimated full-year rebate obligation in our reported results. We estimate that fewer than 20% of our core commercial pools are in rebate status, and these pools represent about 25% of the corresponding premiums. Our estimated rebates are highest in our individual business followed by large group and lowest in our small group business. A high percentage of our rebate exposure is concentrated in just a few of the pools.

Adjusted for favorable development, our second quarter Medicare and Medicaid medical benefit ratios were 85.9% and 88.1%, respectively, both excellent results. Adjusted for development, the Medicare MBR decreased 280 basis points year-over-year, while the Medicaid MBR decreased by 300 basis points. We continue to reflect appropriate assumptions regarding medical cost trend, operating metrics and payout patterns in setting reserves for estimated Health Care costs. Days claims payable were 43.6 days as of June 30, an increase of 0.4 days year-over-year and consistent with our expectations for the quarter. We continue to project days claims payable to be in the low 40s over time.

Group Insurance operating earnings were $44.4 million in the quarter, flat year-over-year. Group underwriting results were solid, with a total benefit ratio of 87.5% in the quarter. We continue to invest in our future to capitalize on marketplace opportunities for future profitable growth and to improve productivity, while ensuring that we appropriately serve the needs of our customers. The second quarter 2011 business segment operating expense ratio was 19.1%, an increase of 100 basis points year-over-year. The increase was a result of lower revenue and increased spending, including IT spending on ICD-10 and Health Care Reform.

The final area of performance I will comment on is our investment performance and management of capital. Second quarter net investment income on our continuing business portfolio was $161 million, a decrease of $14 million year-over-year. Net investment income was slightly better than our expectation due to yields that were better than projected and outperformance in some of our alternative asset portfolios. I would note that our full-year guidance anticipates lower yields and less favorable alternative asset returns in the second half of the year. We have maintained a well-diversified portfolio while managing to total return with a bias to book yield and preservation of capital. At June 30, the continuing business portfolio had a net unrealized gain position of approximately $773 million before tax.

Our financial position, capital structure and liquidity all continue to be very strong. As of June 30, we had a debt-to-total capitalization ratio of 30.3%. We continue to target a risk-based capital ratio of approximately 300% of company action level.

Our strong capital generation and liquidity gives us financial flexibility. We started the quarter with approximately $100 million in cash at the parent. Subsidiary dividends to the parent were approximately $550 million. We issued $500 million of long-term debt and issued $465 million in commercial paper. We retired $450 million of maturing long-term debt. We funded the Prodigy acquisition for $600 million. We repurchased 11.2 million shares for $485 million, and we ended the quarter with a holding company cash balance of approximately $100 million. Our basic share count was 372.9 million at June 30.

For the quarter, Health Care and Group Insurance operating cash flow was $394 million. Year-to-date operating cash flow was approximately $1 billion or one-time year-to-date operating earnings. The second quarter cash flow ratio to operating earnings is seasonally low due to making 2 quarterly tax payments during the quarter.

With this favorable performance for the first half, we are increasing our full-year 2011 operating earnings per share guidance to a range of $4.60 to $4.70. Excluding impacts from our Prodigy acquisition, which is projected to be net neutral to 2011 operating EPS, our guidance increase versus the midpoint of our previous range is driven by the positive prior period development that we experienced in the second quarter, which is equivalent to $0.32 per share based on our full-year share guidance and underwriting margin improvements of $0.18 per share over the remainder of the year versus our previous projection. These increases are offset by higher SG&A investment spending in the second half of approximately $0.10 per share.

Our 2011 projections now anticipate a full-year outlook of 18.2 million medical members, which is flat to the quarter-end membership. Over the remainder of the year, we expect new sales and account retention to improve from our second quarter performance. Our full-year medical membership projection does not include any impact from that Genworth Medicare Supplement transaction, which we expect to close later this year. We also project revenues to be down approximately 1% to 2% for the full-year 2011 when compared to 2010.

With respect to medical benefit ratios in 2011, we project a Commercial medical benefit ratio of 80% plus or minus 50 basis points and a Medicare medical benefit ratio that is in the mid- to high-80s. Our 2011 Commercial MBR projection includes the favorable development reported in the first 6 months, incorporates prudent estimates of our minimum medical loss ratio rebate obligation over the full year and assumes higher medical benefit ratios in the second half of 2011 as utilizations projected to increase and as more deductibles are satisfied.

Our 2011 MBR projections reflect underlying medical cost trends that we expect to be in the 7% plus or minus 50 basis points range, lower by 50 basis points from our previous guidance for 2011. This decline reflects medical cost trend higher than we experienced in 2010, but still lower than our originally projected utilization levels.

With respect to specific medical cost trend categories, our guidance is inpatient cost trending at high single digits, which is unchanged; outpatient cost trending at high single digits, down from our previous projection of high single to low double digits; physician costs trending at mid single digits, which is unchanged; and pharmacy costs trending at mid to high single digits, down from our previous projection of high single digits.

We now project our business segment operating expense ratio to be approximately 19% to 19.5%. This updated projection includes the impact of the acquisition of Prodigy, which contributes approximately 20 basis points of the increase, as well as increased investments in the business over the remainder of the year and negative fixed cost leverage from membership declines. Expense management is a priority for Aetna and many of the investments we are making today will result in productivity and membership gains in future periods.

Further, in a continuing effort to enhance our productivity and optimize our cost structure, we recently initiated a broad-based voluntary early retirement program that is being offered to a substantial number of employees. This program's objective is to create incentives for employees meeting certain age and service requirements to accelerate their retirement plans. While the net effect will be to reduce expenses in 2012, we expect to record a charge related to this program in the third quarter of 2011, which we'll exclude from operating earnings. This charge is not reflected in our guidance.

We project a full-year before tax operating margin of approximately 9% consistent with our increased operating EPS guidance. We continue to expect 2011 to be an excellent capital generation year. Consistent with our earnings guidance and sound operating fundamentals, with respect to cash flow and capital, we project that our 2011 operating cash flow will be greater than our 2011 operating earnings.

Our estimate of dividends from subsidiaries has increased to $2.6 billion from $2.4 billion, resulting from the improved earnings outlook and continual capital structure management. After funding all of our closed and announced acquisitions in year-to-date share repurchases, we will have approximately $500 million of excess capital available for deployment in the second half of the year.

Finally, we project that our debt to capitalization ratio will be approximately 30%. Our acquisition strategy has been increasingly important to our deployment of excess capital. In early January, we acquired Medicity for $500 million, providing a technology platform for our health information technology and accountable care solutions offerings. In June, we acquired Prodigy for approximately $600 million. Also in June, we announced the acquisition of Genworth's Medicare Supplement business for approximately $290 million. And last week, we announced the PayFlex acquisition for approximately $200 million.

While the pace at which we have executed acquisitions has been brisk, our strategic and financial discipline is unchanged, and we are confident in our ability to integrate these properties into the existing Aetna infrastructure. We have the resources to complete these acquisitions while maintaining our enhanced shareholder dividend, our 2011 share count guidance and our capital ratios. These transactions are projected to be accretive to operating EPS when they are integrated and synergies are realized and financially attractive when compared to repurchasing our shares.

Also, as previously announced, on Friday, shareholders of record on July 14 will be receiving their second enhanced dividend payment of $0.15 per share. The dividend is part of Aetna's continuing commitment to increase total return for our shareholders and is testimony to our continued confidence in our strategy, our financial profile and our cash flow. Our full-year operating earnings projection is approximately $1.7 billion to $1.8 billion. Based on our estimate of approximately 384 million weighted average diluted shares, we project full-year 2011 operating earnings per share to be $4.60 to $4.70.

We are very pleased with the strong results in the first half, with $2.78 per share in operating earnings and a year-to-date pretax operating margin of 11%. We note that our actual and projected 2011 medical benefit ratios benefit from substantial prior year development and lower-than-expected utilization. Given the competitive environment, the experience-driven nature of our business and minimum MLR rules, this excellent underwriting performance will be difficult to repeat in the second half of 2011 and in 2012.

Our policy has been and remains to price our products to reflect our best field of medical cost trends and to achieve our targeted high single-digit margins. We continue to work diligently to achieve our short-term and long-term goals.

I will now turn the call back over to Tom. Tom?

Thomas Cowhey

Thank you, Joe. The Aetna management team is now ready for your questions. We ask that you limit yourself to one question and one follow-up so that as many individuals as possible have an opportunity to ask their questions. Operator, the first question, please.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from John Rex with JPMorgan.

John Rex - JP Morgan Chase & Co

I wanted to just get your thoughts broadly on the pricing environment. I take it from your commentary that your pricing posture would still be to match the 7% trend that you're seeing now. And I'm wondering if you can characterize that about what you're seeing more broadly in the marketplace and kind of tie that a little bit to your commentary that you expect to see some growth in Insured for '12 commercial.

Mark Bertolini

Sure. John, Mark Bertolini. We believe that the market continues to be rational from a pricing standpoint. There are occasional market -- specific market issues that we run in from time to time, but largely, the market remains rational. What we are seeing in our own business is, as trend moderates and as we come through the repricing of our book of business in 2010, that our pricing on our risk business is much more in line with the marketplace, and we have a lot more interest in our product.

John Rex - JP Morgan Chase & Co

And Mark, you mentioned an expectation that you'd see robust results in your Medicare Advantage ads in '12, and I guess you haven't had a chance to see other benefit designs out there yet. So I guess I take that as, we should expect to see you're going to significantly expand your footprint in MA for Jan '12. Would that be the right way to view that commentary?

Mark Bertolini

No, I would think more along the lines of the Group business and where we have a lot of Group business onboard in Supplement. For example, we have over 1 million members in our national accounts block of business that are in employer groups, and I would look for it in the Group business next year.

Operator

We'll take our next question from Peter Costa with Wells Fargo Securities.

Peter Costa - Wells Fargo Securities, LLC

Can you talk a little bit more about the CVS transaction, what it's doing for you at this point? And is it performing in line with expectations?

Mark Bertolini

Sure, I will. It is performing ahead of expectations. I'll ask Joe to give you some commentary on the numbers.

Joseph Zubretsky

Well, the integration is going very well, and our customers are very excited about the integrated offering. Just to recount what our strategy was, it was not to get out of the PBM business but to strengthen our PBM offering by forming an alliance with CVS Caremark where we outsourced the rental of their retail networks and their best-in-class administrative platform. So we believe our Pharmacy membership, it has eroded here over the past 18 months before we had that offering in the marketplace. We're confident it will stabilize and grow, and our profitability in 2011 has been enhanced because we implemented those attractive pricing schedules sooner than we expected. And we're still on target for the same level of accretion we previously announced for 2012.

Peter Costa - Wells Fargo Securities, LLC

And have you seen any fallout or any interest in your product relative to others, given the turmoil sort of going on in the marketplace there now for the PBM business?

Joseph Zubretsky

Well, it's going to be an interesting environment with the major announcement, and if that truly is consummated and an integration takes place, it'll be interesting. Anytime a major upheaval in the market happens like that, it's an interesting time to get membership and make your offering more prominent in the market.

Mark Bertolini

Peter, we have a lot of interest in the product as it is now even before the transaction was announced.

Peter Costa - Wells Fargo Securities, LLC

Okay. And can you talk a little bit more about the Medicaid RFP opportunities that are out there right now?

Mark Bertolini

We are actively involved in 8 Medicaid RFP opportunities. We're disappointed in not getting the Louisiana opportunity. They only selected 3 of the 9 bidders. We have not had the debrief on that situation yet and look forward to understanding where we fell short and whether or not there is -- it's appropriate for us to appeal.

Operator

We'll take our next question from Justin Lake with UBS.

Justin Lake - UBS Investment Bank

Mark, you mentioned just previously here that you feel you're much closer to market in terms of commercial risk pricing for 2012. Should we take that to mean that you targeted lower margins in certain products for next year versus 2011, I think as you had previously discussed? And can you give us any color on what we should think about the impact or the magnitude of change there to 2012 Commercial MLR versus this year?

Mark Bertolini

I think the way to think about it, Justin, first is that we're not giving any 2012 guidance beyond what we've given on the call already. But secondly and probably more importantly is that we will maintain our pricing model to price to trend, plus high single-digit margins are target profit margins on the business. And so depending on where that case comes from and the cohort it comes from and where its experience is depends on how we price it.

Justin Lake - UBS Investment Bank

Right. Just to be clear, I think you had said last quarter that you were seeing some markets be well above -- you'd kind of overshot the mark when you had repriced the book in 2009. So I'm just trying to think about -- yes, I know there are places where you're underpriced and overpriced, but just curious. Do you think that in net basis, do you feel like to get back to market, you had to lower pricing more so than increasing other markets?

Mark Bertolini

The only place we've actually lowered our premiums on a dollar basis has been in a few individual markets. We don't see lowering premiums in any other markets, and it's about the rate of rise and where that group is based on their experience. Remember, a large block of our commercial risk business is experience-rated, and then the rest are book-rated, which largely to be determined by the pools and how the Commercial MLRs come out relative to our rebates.

Justin Lake - UBS Investment Bank

Okay, great. Just the last question, given the much better upside in the Commercial MLR, I'm just curious if there's any color you can give us in terms of how much potential there is there for further MLR improvement going to the year and into 2012 should cost terms remain moderate given the existence of MLR of course? In essence, Joe, I know you have this great spreadsheet that looks at each one of your pools and tell you where you are versus the floor. Is there any color you can give us as we go through the year on how close you are to the floors and how much further upside there might be?

Joseph Zubretsky

I think what I'll say in answer to the forecast is as follows: we produced a 77.4% Commercial medical benefit ratio for the first half of the year. And when you remove the prior year development, that post is 79.1%. If you think about our 80% guidance for the full year, that would imply an 82% to 82.5% medical benefit ratio on the Commercial side for the second half of the year. Now we are forecasting an uptick in utilization. We just think that it's inevitable that the very low utilization we're experiencing today rebounds and surges at some point, and let's not forget the back half seasonality due to the heavy takeup rate of CDHP and the wearing off of deductibles. So we're very confident with that forecast. And yes, it is over 82% for the second half, but we are appropriately cautious in that outlook. With respect to rebates, we have a very sophisticated infrastructure. We've accounted for it at 50% of our full-year estimate. As the year goes on, the level of variation and variability will narrow, and the estimate becomes more precise. And as I mentioned many times, whether we ever spike that out and disclose it separately, it still remains to be seen, but a very prudent forecast of our MLR rebates is included in our MLR guidance for the full year.

Operator

We'll take our next question from Doug Simpson with Morgan Stanley.

Doug Simpson - Morgan Stanley

Joe, I was wondering if you could just give us color on where do you think the unit price differential sits today. And how much can you close that? And I guess just -- as we're thinking about the unit price differential that you mentioned, within the ASO book, how important -- I think you mentioned the ASO enrollment coming down next year. How important is that as you're trying to improve your unit price position? Is there sort of a negative feedback on that? Or is that not really an issue?

Joseph Zubretsky

There's really 2 markets that are emerging out there, Doug. One is a market that is focusing on what they call hard dollar savings. A higher discount on a known unit of utilization will score higher than a longer-term outlook of more effective management of quality and total cost. And as you know, our MO and our strategy over the years is to manage the total Medicare cost wallet very, very effectively. So in certain cases, when the consultants and their clients will place more reliance and score raw discounts more highly, sometimes our product does not show as favorably. So we're continuing to improve our discount position in markets where we think we are lagging. We are focusing on customers that still value the fully-integrated total quality and cost approach, and we're comfortable that our national account franchise at 8.5 million members plus continue to be profitable and grow from this base.

Doug Simpson - Morgan Stanley

And how do you see the unit price differential playing out in the commercial risk?

Mark Bertolini

I think the way to think about it, Doug, is that in the commercial risk pricing environment, we price in our unit costs and all the other products and services we offer that manage those medical costs. So the total cost proposition actually resonates very well in the commercial risk market because it gets reflected in the premium. And we believe our premiums after repricing through 2010 are in line with the marketplace and competitive where we want them to be.

Operator

We'll take our next question from Ana Gupte with Sanford Bernstein.

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

It seems on a bunch of small acquisitions, I was hoping you could provide some perspective on the Express Medco deal. And would that, in any way, encourage the managed care space to think bigger either for scale and/or diversification? And specifically, would you continue along your path of smaller deals? Or would you contemplate something bigger than that?

Mark Bertolini

Well, I think, Ana, what we've been talking about for the last 3 quarters is that our acquisition strategy is focused on capabilities, particularly in the government space, the HIT space. And I think the Prodigy acquisition was very much aimed at getting to a different cost model in the large self-funded and middle-market self-funded case where we can offer a different price point to be competitive in that market segment as the large accounts segment starts to diverge on a self-funded basis. I think as we look at going forward, we believe that the deal we did with CVS relative to our PBM gives us as good a position as any other deal in the marketplace and any independent PBM in the marketplace. And that while we have -- as Joe said earlier, we have not gotten out of the business. We have strengthened our product offering, and so we believe the Express Scripts Medco merger presents a potential for some opportunities should there be fallout as part of that integration. I think, finally, on large-scale acquisition, we think about scale from the standpoint of local market, and I think what you're going to see us do as an organization over the next 8 quarters as we get ready for exchanges is size our organization to fit the right marketplaces where we believe we can be competitive and to drive to a price point that will be of some advantage in the exchanges in 2014, should we get the exchanges in 2014.

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

And then as far as this local market acquisition you're talking about, there was an expectation at one time that we'd see at least some shake out of smaller commercial plans, and maybe the low utilizations kind of kept that at bay. But are you scouring around for targets there? And should you find anything, what would be your capital management strategy? And any more funds release from Vitality Re, would you lever off to do more deals?

Joseph Zubretsky

Ana, this is Joe. We have a very active pipeline and a dedicated team scouring various attractive geographies for role of opportunities on small regional plans both for profit and non-for-profit. We're finding those discussions to come more freely as these small enterprises deal with the fixed cost of Health Care Reform, the lack of scale and of course minimum MLR pools without potentially attractive credibility features. So those conversations are becoming a lot more frequent, and whether we'll action one or not, it's just hard to tell. And our view is those are -- depending on the other uses of capital, those are adequately funded out of available resources and current cash flow. With respect to capital transactions, again, we're continuing managing capital as evidenced by our recent forecast of $2.6 billion of subsidiary dividends. That's an incredible result for the year, and you're going to see us continually work the capital base to create shareholder value.

Operator

We'll take our next question from the line of Scott Fidel with Deutsche Bank.

Scott Fidel - Deutsche Bank AG

First question is if you can maybe drill in a bit more into some of the increased investments that you're planning to make in the back half for future growth, then maybe you can talk about if those are weighted towards any particular market or product segment or just some of the specific initiatives that you're planning to take on.

Mark Bertolini

I think, Scott, the way we think about it is as we look at the earnings profile for the year, we think this is a good opportunity and timing to invest, and Joe will cover some of the areas where we believe we can be investing in our infrastructure.

Joseph Zubretsky

Scott, that additional $0.10 that we included as a drag to our guidance is going to be really focused on membership. We know we've been challenged on the membership line here in certain segments and geographies over the past few months, and we are going to aim those funds at marketing, media, intensity around open enrollment periods in certain geographies, certainly turning back on the Medicare media and advertising program. So all aimed at membership and getting off to a good start in 2012.

Scott Fidel - Deutsche Bank AG

Okay. And then just had a follow-up question. Are you seeing any shifts in the market share landscape for 2012 around national accounts? WellPoint just had their call and guided for flat national accounts, which is a deceleration for them, and you're guiding for down 500,000. So clearly, somebody out there is growing. So are we seeing United emerge more actively in terms of gaining share for '11? Or are there any other elements to consider in terms of the market share?

Joseph Zubretsky

Scott, I think you're just going to have to wait until everybody announces their 2012 outlook. It's hard to speculate who the winners are. But I will tell you this, if you look over a longer period of time, this tends to be a cyclical business. And whether you're running on favorable or unfavorable discounts, running on service levels that are working or not working, we built up 1 million members from 2006 to 2008 and obviously are giving some of that back. So it goes in cycles, and we're just confident that we can grow off of this base.

Operator

We'll take our next question from the line of Charles Boorady with Crédit Suisse.

Charles Boorady - Crédit Suisse AG

Joe or Mark, I just wanted to ask you to expand on your comment about the cyclicality in the business and how you see the cyclicality playing out with respect to your strategy for enrollment growth. Specifically, for example, in '09, you had 5% commercial risk enrollment growth, but the MLRs were up 410 bps. 2011, you've got a 7% drop in commercial risk, but the MLRs have improved 220 bps. So is it right to think about this relationship between pricing for higher MLR but you pick up enrollment or pricing improve the MLR and you lose enrollment? And is this just an inevitable part of the business? Your comment, Joe, about being able to grow from here, do you think there's going to be less cyclicality going forward that you have a strategy to grow the top line going forward without having to give up margin to get it?

Mark Bertolini

Well, Charles, this is Mark. I think you're talking about a couple of things here. First on the self-funded side, we believe that the economy is driving a lot of the behavior on the part of employers looking for hard dollar savings, and that plays a certain value proposition of certain carriers in that marketplace. Joe mentioned earlier the service levels that move from time to time between organizations and whether or not they lose customers because their service model gets into trouble in some way, shape or form, all reacting to financial results in some way. I think in the Insured market, you're talking about the underwriting cycle, and I'm not sure whether or not the underwriting cycle or how it behaves going through Health Care Reform with the MLR targets in place and rebates, which could actually create a smoothing mechanism. And Joe, I don't know if you have any other comments on MLR.

Joseph Zubretsky

Charles, I think you have to accept as a matter of fact that any business that has -- is the business of underwriting has some level of cyclicality to it, but I would argue this, that the large peaks and troughs you've just recently experienced were more or less caused by incredible inflections. In '08, '09 medical cost inflection, nobody could have been priced ahead of that, and quite frankly, we're seeing the boomerang effect of that right now. Utilization is so unusually low that everybody's priced ahead of it. So I would argue that this boomerang effect of the inflection point we saw in '08 and '09 is causing this period of time to look a lot more cyclical than it will appear going forward.

Charles Boorady - Crédit Suisse AG

Okay. I mean, and basically I think that's a fair point. The cycle was more extreme than normal, but I guess my point is there's been a cycle. It's a cyclical business, but going forward, is there a way to drive the top line without -- while still maintaining discipline on pricing and maintaining margins and whereas getting at potentially M&A of large health plan acquisitions we just haven't seen. And I wonder if you think that's a better way to grow the top line going forward because inevitably, Wall Street starts to look for top line growth. And when companies use price to get it, that takes you down a slippery slope, and I'm not seeing evidence of that today. And I'm just wondering what your view is going forward. Do you see the industry going into this -- the next down cycle of aggressive pricing? Or do you think we'll see some health plan M&A to drive top line growth that way?

Joseph Zubretsky

Let me answer the last part first. You're definitely going to see health plan M&A, and whether it's all-out full acquisition, buying the goodwill of a franchise enterprise or whether it's a roll-up strategy, a migration deal and only paying for members you retain, all of those models are very attractive. And you'll see us at least attempt to participate in that type of inorganic growth. On the other side, Mark and I have been consistent on this. We would like to have both profit and growth, but if you have to choose between one or the other, you take margin and profit and you sacrifice the growth line. That's the way you have to manage this business. Getting out in front of a pricing gap is far too difficult and far too painful. So you're going to see us err on the side of margin and profitability and grow if we can.

Operator

We'll take our next question from Matt Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs Group Inc.

And actually maybe I'll just stay on this topic because I think -- a little confusing there, it sounded like in the last question, you drifted from talking about a cyclicality with respect to national accounts, which is mostly ASC relative to underwriting cyclicality, mostly in the risk business. Was that -- are you pointing to a relationship between the two? Or are you really talking about not directly related dynamics where in national accounts, you have cycles, if you will, of one large carrier or 2 gaining accounts from others and then vice versa?

Mark Bertolini

It's separate dynamics, Matt.

Joseph Zubretsky

Sorry for the confusion. But what I meant was that there was a recent period of time where we grew by 1 million members because our service model is showing the discount gap wasn't as wide. It got away from us a little bit, and we've given up those members and we can get back to where we were. So it's a different dynamic, but it does tend to be cyclical as some carriers are in favor and others might be out for a certain period of time.

Matthew Borsch - Goldman Sachs Group Inc.

Yes, yes. So what would you characterize as the key drivers of the anticipated 500,000 member loss coming into January of next year? Is that -- are those buyers doing it more narrowly on network pricing? Is that the issue? Are there idiosyncratic issues that are separate to maybe a couple of the large accounts there?

Mark Bertolini

So there's -- first of all, there's 2 large accounts that are 300,000 and have 500,000 members. So I think that's important to note. Secondly, it is largely, if not totally, driven by discount analysis. And while we understand the need to score hard savings by doing a comparison of hospital unit price discounts between carriers, our belief is just that, that in the long run is not an appropriate way to look at the cost structure of your underlying employee benefits. One simple example: in the case of $1,000 CAT scan in the hospital with a 50% discount or a $500 CAT scan in an ambulatory facility with a 30% discount, the latter would receive an inferior score from the consultants and will be considered less savings as a result of that comparison on unit price discounts. So that is the battle we are fighting, and we can see the validation of our total cost approach by looking at our commercial large group commercial business where we are pricing in the total cost solution and putting premiums in the marketplace that are competitive.

Matthew Borsch - Goldman Sachs Group Inc.

And why do you think -- I mean, this is obviously a battle you guys have been fighting for a long time. But have you seen the pendulum swing among consultants towards a more pure unit price comparison and away from looking at the total medical cost picture that arguably they should be? Or has that just become more prominent in reaction to recent economic pressures?

Mark Bertolini

I think it's the latter. It's become more prominent in reaction to recent economic conditions, particularly with procurement and the CFO getting involved in the Health Care cost purchase. And so they're looking for a hard dollar savings that can be penciled into the ledger to say, "I saved 5% on unit hospital pricings that I can book." Now whether or not that leads to more appropriate utilization is a bigger issue, and so we understand how we could get to those discount levels. We could pursue pushing people into the hospital for the CAT scan. We don't believe that's an appropriate way to manage the business, and so for those clients, we make that argument. Where it doesn't hold, we move away from the business.

Operator

We'll take our next question from Carl McDonald with Citi.

Carl McDonald - Citigroup Inc

Another M&A question which is, I wanted to see how your Medicare M&A strategy has either evolved or not evolved post the Genworth transaction.

Joseph Zubretsky

I'm sorry, Carl. Can you -- we had trouble hearing the first part of your question. Can you repeat it, please?

Carl McDonald - Citigroup Inc

Just another M&A question focused specifically on Medicare. I'd be interested to see how your Medicare acquisition strategy has either evolved or not evolved post the Genworth transaction.

Mark Bertolini

We believe that we needed to be in the MedSup business because that's an important part of the Medicare product mix. We tried to build it. We were not successful in building it on our own. And so we went and looked for a number of partners that we could consider in the MedSup business, and Genworth appeared to be the best opportunity for us. And that's why we pursued that transaction. We continue to be interested in the Medicare space. Obviously, it has to fit with our return profiles and the business mix that we already have, but we continue to be interested in the Medicare space.

Carl McDonald - Citigroup Inc

Did you -- I know you've heard -- been relatively happy with the employer Medicare business. Do you think that the retail Medicare business that you have is picking up from a scale perspective?

Mark Bertolini

We believe that we need to continue to grow the retail business to Medicare, and we've made -- part of the investment that Joe mentioned earlier was to begin the branding and ad campaign to get more of the retail business going. That takes a little while. That's why we see the January numbers being largely dominated by group enrollment, but we believe the retail business will be indeed important, particularly as employees of employers that don't offer retiree coverage age out of our Commercial business and into the Medicare market.

Operator

We'll take our next question from the line of Kevin Fischbeck with Bank of America.

Kevin Fischbeck - BofA Merrill Lynch

Okay, great. You mentioned a couple of times how good the cash flow to the parent this year is shaping up, and it's cyclically better than what you guys thought it would be at the beginning the year. But how should we think about that number for next year? Should it be -- should return back towards normal? Or is there still more things you can do on the capital extraction front?

Joseph Zubretsky

No, Kevin, this is as about as good as it's going to get. Obviously, on a normalized basis, your dividend capacity is usually limited to the prior year statutory income. Now last year, we made about $1.5 billion, $1.6 billion of staff profits, but we had all of the special capital raising initiatives we did this year. And of course, we did not grow the top line, which means we had to leave less capital behind in our regulated subsidiaries to fund organic growth. So the lack of top line growth, the fact that we had capital gains in the [indiscernible] portfolio, a great earnings year last year and the capital enhancing initiatives all created sort of a triple witching effect of having the subsidiary dividends be at their highest level. Over time, you'll see dividends return to prior year statutory profits.

Kevin Fischbeck - BofA Merrill Lynch

Okay, that's helpful. And then as far as the SG&A commentary, I mean, maybe I missed it. Because you talked about the topic a couple of different times, but I didn't hear exactly what the outlook was for 2012. And over time, you guys think you're going to be able to get leverage on that number every year. But the commentary about spending a little bit more on the second half on SG&A, do you think you won't be able to achieve that improvement next year because of the full-year impact of the investments you're making in the second half? Or are there things you're doing about the mandatory retirement or the retirement offers? Is that going to leave you back to a normal trend on SG&A?

Joseph Zubretsky

We're not giving any specific guidance on 2012 SG&A, except for our longer-term commitment is that two things happened during the year: one is, create fixed cost -- positive fixed cost leverage because we're growing membership; and second, continue to work on the productivity line, and we've been very successful over the years creating productivity gains in the portfolio. So I'm not giving any specific outlook on next year, but to reiterate, the spending in the second half of the year is clearly aimed at growing membership.

Mark Bertolini

And it's a one-time effect, it's not a rollover effect into 2012, Kevin. And the ERP program that we've launched will be a charge in the third quarter depending on what the size of the number of employees. We accept that was obviously a positive impact rolling into the next few years.

Operator

We'll go next to the line of Christine Arnold with Cowen and Company.

Christine Arnold - Cowen and Company, LLC

Could you clarify for me your discount strategy? I'm hearing that you're committed to becoming more competitive on the discounts, and yet you feel as if your strategy is the right one for total costs. And also, with the acquisitions that you guys have done, would we expect your service versus risk profile to change over time? Or does that really just support kind of the growth that you'll see in the risk side of the business?

Mark Bertolini

I think first on the discount strategy, Christine, we are intent on improving our discounts where we can go. We are not perfect. We have some ways to go, and we've been executing that against our contracts. That takes a while to execute against, and the consultant databases usually lag 1 year to 18 months behind. So we've been working on that this last year. We continue to push it. We believe that for the 2013 national account selling season, we'll be in good shape with our discount profile, vis-à-vis our competitors. As it relates to the second part of your question...

Christine Arnold - Cowen and Company, LLC

So this is a risk profile over time in terms of...

Mark Bertolini

I think you'll see our service fees pick up, but we do have a large risk profile. And so therefore it will have to be a lot of service business to meaningful change the mix.

Christine Arnold - Cowen and Company, LLC

Okay. So probably not much of a change over the next couple of years?

Mark Bertolini

Right.

Operator

And we'll take our last question today from the line of Joshua Raskin with Barclays Capital.

Joshua Raskin - Barclays Capital

I guess just on the -- final question I guess on the discount issue, and then I guess I have a quick follow-up hopefully. Is there a way to educate the consultants in that business? I mean, you talk about how they're probably just taking someone else's claims and running them through the Aetna engine and saying your discounts would have been less. But is there a way to explain that, that claim would not have occurred in that inpatient setting and instead you would have had, as you mentioned a CAT scan and in outpatient facility, that would have saved you 50% on that claim? How do you sort of overcome that?

Mark Bertolini

Well, I think the way to think about it is we are educating. We're spending time with the consultants. But what the consultants all have and what they can rely on having from a data standpoint, Josh, is that they have a network discount database where they can run those analyses on their own. Running the broader total cost proposition is a much harder one and much more difficult to get across to clients. And so we're working with them to try and figure out those models. They are engaged in the conversation with us on why we believe that our approach is a longer-run, more valuable approach. And that will take some time, but we are engaged in that discussion.

Joshua Raskin - Barclays Capital

Okay. And then just a quick last follow-up. You mentioned headwinds and tailwinds, I guess, going into next year. You're not giving '12 guidance, but you talked about a 10% earnings growth rate long-term in the next year. I'm just trying to figure out the CVS transaction. I think, Joe, you said you're still on schedule, which I believe was another $0.25 of accretion next year. Are those sort of mutually exclusive? Or should we think about CVS as part of that 10% per year process?

Joseph Zubretsky

Well, to be clear, the 10% guidance was a compounded average growth rate over time. It wasn't a year-to-year growth rate, and I would characterize it this way. I think we talked about them in our prepared remarks. The Commercial medical benefit ratio at 80% and the trend levels at this level are probably unsustainable. We certainly have the national account membership challenge for the first part of the year. The low growth economic environment will probably be a struggle for the entire industry. And lastly, yields are not getting any better in the investment portfolio. We're still well diversified, conservatively invested, but rates are on a downward trend, not on the upward trend. In terms of opportunities, CVS, as we said, we're reiterating our guidance for 2012. That will be a positive impact. Don't forget that we've repurchased nearly 18 million shares already this year, and therefore, you get the pickup in EPS from that. So there is plenty of positive momentum going into 2012, obviously some challenges as well. But bear in mind that long term growth rate was a compound annual growth rate, not a point-to-point.

Joshua Raskin - Barclays Capital

Okay. I guess I was just trying to size these opportunities versus the headwinds, and you didn't mention obviously the acceleration in investment spending this year that I assumed it's not planned on recurring. But besides that, which ones are bigger than the others?

Joseph Zubretsky

Well, I would just say you'll have to just wait for us to be a little more granular on our 2012 guidance.

Thomas Cowhey

A transcript to the prepared portion of this call will be posted shortly on the Investor Information section of aetna.com. If you have any questions about matters discussed this morning, please feel free to call me or one of my colleagues in the Investor Relations office. Thank you for joining us this morning.

Operator

And thank you, ladies and gentlemen, for your participation. This will conclude today's conference call.

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