Aetna (AET) Mark T. Bertolini on Q4 2015 Results - Earnings Call Transcript

| About: Aetna, Inc. (AET)

Aetna, Inc. (NYSE:AET)

Q4 2015 Earnings Call

February 01, 2016 8:30 am ET

Executives

Thomas F. Cowhey - Vice President-Investor Relations

Mark T. Bertolini - Chairman & Chief Executive Officer

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Karen S. Lynch - President

Analysts

Joshua R. Raskin - Barclays Capital, Inc.

A.J. Rice - UBS Securities LLC

Kevin Mark Fischbeck - Bank of America Merrill Lynch

Christine M. Arnold - Cowen & Co. LLC

Peter Heinz Costa - Wells Fargo Securities LLC

Andrew Schenker - Morgan Stanley & Co. LLC

Gary P. Taylor - JPMorgan Securities LLC

Ana A. Gupte - Leerink Partners LLC

Scott Fidel - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Matthew Borsch - Goldman Sachs & Co.

David Howard Windley - Jefferies LLC

Chris Rigg - Susquehanna Financial Group LLLP

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

Brian Michael Wright - Sterne Agee CRT

Michael J. Baker - Raymond James & Associates, Inc.

Frank Morgan - RBC Capital Markets LLC

Operator

Good morning. My name is Kevin and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the Aetna Fourth Quarter and Full Year 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there'll be a question-and-answer period. As a reminder, this conference is being recorded. I would now like to turn the conference over to Tom Cowhey, Vice President-Investor Relations. Mr. Cowhey, you may begin.

Thomas F. Cowhey - Vice President-Investor Relations

Good morning, and thank you for joining Aetna's fourth quarter 2015 earnings call and webcast. This is Tom Cowhey, Vice President of Investor Relations for Aetna. And with me this morning are Aetna's Chairman and Chief Executive Officer, Mark Bertolini and Chief Financial Officer, Shawn Guertin. Following their prepared portion of the remarks, we will answer your questions. Karen Lynch, Aetna's President will also join us for the Q&A session.

During this call we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future result to differ materially from currently projected result are described in this morning's press release and the reports to be filed with the FTC. We have also provided reconciliation to certain non-GAAP measures in our financial supplement and guidance summary. Further, to assist investors in understanding our initial 2016 guidance, we have prepared a short presentation with additional details on our outlook. The reconciliations and presentation are available on the investor information section of aetna.com. Finally, as you know, our ability to respond to certain inquiries from investors and analysts in nonpublic forums is limited, 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 T. Bertolini - Chairman & Chief Executive Officer

Good morning. Thank you, Tom, and thank you all for joining us today. This morning Aetna reported full year 2015 operating EPS of $7.71, exceeding our previous projection and representing a record result for the company and year-over-year growth of 15%, exceeding our long-term targeted range. Looking back on 2015, we generated record annual operating revenue of over $60 billion, achieved our high single-digit operating margin target for the fifth consecutive year, achieved our targeted pre-tax operating margin in our individual Medicare Advantage business one year ahead of our projections, exceeded our initial operating EPS projection by 12% despite headwinds in our ACA related businesses and lower than projected share repurchases, increased our projected 2015 operating EPS five times and announced our agreement to acquire Humana, the largest transaction in the company's history.

Aetna's strong 2015 results speak to our continued focus on disciplined pricing and execution of our growth strategy. Underlying these full year results, we ended the year with nearly 23.5 million medical members, exceeding our previous year-end membership projections. We reported a 350 basis point year-over-year improvement in our government medical benefit ratio, driven by strong underwriting results in both our Medicare and Medicaid businesses.

Our large group Commercial business had solid performance as aggregate commercial medical cost trends remain moderate. And we generated strong cash flow in 2015, which enabled us to return capital to shareholders through share repurchases and shareholder dividends and still build cash, as we begin to position our balance sheet for the projected closing of the Humana acquisition in the second half of 2016.

Based on our strong finish to 2015, this morning we provided an initial 2016 operating EPS projection of at least $7.75. Consistent with past practice, this projection does not include any assumption of prior year's reserve development and represents significant growth over our 2015 operating EPS baseline of just over $7.00 per share.

In a few moments, Shawn will discuss our 2015 results and 2016 guidance in greater detail. But first, I would like to provide a brief update on the Humana acquisition and discuss some of the operational highlights for the year.

Beginning with the Humana acquisition, we continue to work diligently with the Department of Justice and with state regulators toward final approval of the transaction and continue to advance our integration readiness plans. We have obtained seven of the necessary state approvals required to close the transaction and we believe we remain on track to close in the second half of 2016.

Moving to operational highlights. The fourth quarter capped off an outstanding year for our Government business, which continues to be a key growth engine for Aetna. More specifically, we continue to expand our Medicare business, where we grew membership by over 13% year over year, consisting of over 22% growth in Medicare supplement membership, nearly 15% growth in individual Medicare Advantage membership, and 4% growth in our group Medicare Advantage membership. This level of membership growth during a year in which we also improved our margin profile in this business is a testament to our focused execution of our strategy to deliver profitable growth.

Additionally, we had another strong Medicare Advantage annual election period and now project that we will grow our membership by over 6% in the first quarter of 2016, including 10% growth in our individual Medicare Advantage membership. Our continued above-average growth directly speaks to the importance of our top-tier STAR ratings and continued investment in programs that our customers value. Finally, we also project that we will grow our PDP membership by over 450,000 members in the first quarter of 2016; strong growth in a business that generated solid margin performance for Aetna in 2015.

Our Medicaid business also performed very well in 2015, despite a number of meaningful headwinds that included exiting our Delaware Medicaid contract at the beginning of the year, absorbing a meaningful rate reset in our largest Medicaid contract, and implementation delays and higher-than-projected opt-out rates in our various duals demonstration contracts. Despite these challenges, we grew Medicaid membership by 176,000 members, grew Medicaid revenues at double-digit rates, and achieved underwriting margins that exceeded our initial 2015 projections. Looking forward, we continue to believe that the breadth of our platform will enable us to continue to drive long-term top and bottom line growth in our Medicaid businesses.

Shifting to our Individual Commercial business, we ended 2015 with approximately 1 million Individual Commercial members both on and off exchange. Based on our most up-to-date view of open enrollment, we do not expect material growth in this business in the first quarter of 2016. Our Individual Commercial business ended the year with improved results over our most recent outlook.

However, despite our improved finish, this business remained unprofitable in 2015, and we continue to have serious concerns about the sustainability of the public exchanges. Specifically, we remain concerned about the overall stability of the risk pool, including enforcement of standards related to special election period enrollment, where CMS has made some recent changes, but more needs to be done. The lack of predictability and full transparency of the risk adjustment program, which is key to long-term program health, especially as the other two premium stabilization programs expire in 2017; and newly-proposed CMS regulations on network adequacy and standardization of benefits that would limit our ability to offer affordable, innovative on-exchange products. We continue to work constructively with CMS and lawmakers to set this program on a more sustainable path and achieve the underlying goal of making healthcare more affordable and accessible.

Finally, we made meaningful progress in furthering our consumer and provider engagement efforts during 2015, in that we delivered approximately 37% of our medical costs through a value-based arrangement and launched new consumer-centric products in select geographies, often backed by an ACO or value-based network agreement. The Humana acquisition will only accelerate our efforts to transform into a more consumer-centric company and achieve our mission to build a healthier world.

In summary, we are pleased with our 2015 results, and as we enter 2016, we are focused on two main objectives: delivering on our 2016 operating EPS projections and executing a successful closing of the Humana acquisition. I want to thank our employees for their efforts in delivering yet another strong year for Aetna. I remain confident that: we have the right vision to be a leader in the changing healthcare marketplace, we can continue to execute on our differentiated strategy, we will close and successfully integrate the proposed Humana acquisition, and we can achieve our 2016 operating earnings per share projection of at least $7.75.

I will now turn the call over to Shawn, who will provide additional insight into our 2015 results and our 2016 outlook. Shawn?

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Thank you, Mark, and good morning, everyone. Earlier today, we reported full-year 2015 operating earnings of $2.7 billion and operating earnings per share of $7.71, a 15% increase over 2014 and well in excess of our initial guidance for 2015. Aetna's operating results continue to be supported by strong cash flow and operating margins.

I will begin with some comments on our full-year 2015 performance. We ended the year with nearly 23.5 million medical members, approximately 200,000 members more than our previous projection, primarily driven by higher than projected Commercial Insured membership. We grew operating revenue to a record $60.3 billion, which included 9% premium growth in our Government businesses. Our full-year Commercial Medical Benefit Ratio was 80.3%, a solid result that benefited from continued moderate medical cost trend and is consistent with our previous projections. Our full-year government medical benefit ratio was 81.4%, an outstanding result that reflects the ongoing execution of our strategies to improve Medicare margins and continued strong performance in our Medicaid business. Finally, we generated $2.4 billion in net subsidiary dividends and returned $645 million to shareholders through share repurchases and shareholder dividends.

Looking at our fourth quarter results, our top line performance was steady for the quarter at $15 billion of operating revenue. Our pre-tax operating margin was 6% for the quarter, a 50 basis point year-over-year improvement. Our total Health Medical Benefit Ratio was 81.9%, a 110 basis point year-over-year improvement. This strong result benefited from disciplined pricing, continued moderate medical cost trends, and favorable reserve development. Our operating expense ratio was 21%, an 80 basis point increase over the fourth quarter of 2014 but consistent with our previous projections.

From a balance sheet perspective, we remain confident in the adequacy of our reserves. We experienced favorable prior-period reserve development in the quarter across all of our core products, primarily attributable to third quarter 2015 dates of service. Our reserve growth exceeded our premium growth and days and claims payable were 54.9 days at the end of the quarter, steady sequentially and up 5.7 days on a year-over-year basis

Turning to cash flow and capital, operating cash flows remain strong. Our full-year Health Care and Group Insurance operating cash flows were 1.6 times operating earnings. Our ability to repurchase shares was constrained by the proposed Humana acquisition and we did not repurchase any shares during the quarter. We did, however, distribute $87 million through our quarterly shareholder dividend.

In summary, we are quite pleased with the strength of our full-year results. I will now discuss the key drivers of our fourth quarter performance in greater detail. Beginning with Commercial business, our total Commercial Insured membership declined by 112,000 members during the quarter, largely driven by our small group and individual businesses. Our Commercial Medical Benefit Ratio was 81.3% for the quarter, slightly better than our previous projections and a 70 basis point improvement over the same period last year.

Our fourth quarter Commercial MBR was influenced by continued moderate medical cost trends, strong performance in our large group Commercial business and increased favorable prior-period reserve development, primarily related to our Individual Commercial business. Consistent with our Commercial MBR performance, Aetna's 2015 Core Commercial medical cost trend was approximately 6%, consistent with previous projections.

With respect to the performance of our Individual Commercial business, we continue to take a prudent stance as we update our estimates related to certain ACA programs in advance of the 2016 reconciliation. The update of these estimates in the fourth quarter of 2015 resulted in better operating result than previously projected, driven by lower medical costs and improved risk adjustment estimates. Based on these updated estimates, Aetna's Individual Commercial business generated full-year 2015 pre-tax operating losses of approximately 3% to 4%, a disappointing result, but one we are increasingly confident we can improve upon in 2016.

Moving to our Government businesses, we grew by 114,000 members in the quarter led by growth of 77,000 members in Medicaid, driven by in-state expansion and new program starts, and growth of 32,000 members in Medicare Supplement. Our fourth quarter 2015 Government premiums grew to $5.8 billion, an 8% increase over the prior year quarter. Our government medical benefit ratio was 82.6% in the quarter, a very strong result and a 180 basis point improvement over the same period last year, driven primarily by continued momentum in both our Medicare and Medicaid businesses.

Moving on to the balance sheet, our financial position, capital structure, and liquidity all continue to be very strong. At December 31, we had a debt-to-total capitalization ratio of approximately 33%. Looking at cash and investments at the parent, we started the quarter with $180 million; net subsidiary dividends to the parent were $577 million; we paid a shareholder dividend of $87 million; and after other uses, we ended the quarter with approximately $420 million of cash at the parent. Our basic share count was 349.3 million at December 31.

Shifting to 2016, this morning, we provided a stand-alone 2016 operating EPS projection of at least $7.75. As Mark mentioned earlier, our initial 2016 operating EPS projection excludes prior year's reserve development and assumes no share repurchases. As a result of the outperformance in 2015, relative to our previous projection, our view of Aetna's 2015 baseline operating EPS has improved to just over $7 per share.

While there are many puts and takes in our initial outlook, our projected 2016 operating EPS growth off of our 2015 baseline reflects margin improvement in ACA-compliant businesses, which includes ACA-compliant small group and individual businesses; operating earnings leverage, as we continue to drive net productivity gains in excess of inflationary costs and appropriately position our infrastructure to be consistent with projected membership levels; and continued top line growth, particularly in our Government businesses. These opportunities are partially offset by the full-year impact of the Kentucky Medicaid rate reset, the impact of ASC customer losses on our Group Insurance business, and the impact of the 2017 suspension of the Health Insurer Fee as we begin to reflect this change in 2017 renewals with member months in 2016.

Our 2016 operating EPS guidance is further influenced by the following drivers. Based on our year-end 2015 medical membership results, we project that our first quarter 2016 membership will be in the range of 22.7 million to 22.8 million medical members. The primary drivers of this first quarter decline in medical membership are projected to be Commercial ASC declines of approximately 750,000 members related to previously disclosed membership losses, including those associated with our Assurant relationship; group Commercial Insured declines of approximately 180,000 members, reflecting our continued pricing discipline, partially offset by continued growth in our Government businesses of approximately 170,000 members.

We project 2016 total operating revenue to be approximately $62 billion. This top line projection is a result of continued strong growth in our Government businesses, partially offset by our group Commercial blocks of business reflecting our ongoing pricing discipline.

We project our 2016 Core Commercial medical cost trend to be in the range of 6% to 7%, a 50 basis point increase over 2015 at the midpoint of this range. We project our full-year Total Medical Benefit Ratio will be 81.6%, plus or minus 30 basis points.

Our current view is that our full-year operating expense ratio will be less than 18.5%, a result of continued productivity improvements and changes in mix. We project our pre-tax operating margin to be at least 8%, consistent with our high-single-digit target with operating earnings of at least $2.7 billion.

Finally, we expect that net subsidiary dividends for the year will be at least $2.3 billion and Aetna's parent cash balance will be at least $1.9 billion at year-end. We project that our 2016 weighted average diluted share count will be between 354 million and 355 million shares, reflecting our limited ability to repurchase shares as a result of the proposed Humana acquisition.

Opportunities that could favorably impact our current 2016 operating EPS outlook include the potential for 2015 reserves to develop favorably and the potential for additional favorability as we complete the reconciliation of certain programs related to our ACA-compliant businesses in 2016. Potentially offsetting these opportunities are the ever-present risk that medical cost trends could increase by more than we have projected, the risk that our projections of risk-adjusted revenue in our ACA-compliant businesses may not be achieved, and the risk that membership could be less than currently projected.

Finally, to the extent that current analyst consensus for 2016 contemplates the same quarterly earnings progression Aetna experienced in 2015, especially as it pertains to the first quarter, we would remind investors that the first quarter of 2015 was materially impacted by prior year's reserve development, which we are not projecting to recur.

In closing, I am very pleased with the strength of our fourth quarter and full-year 2015 results, which meaningfully exceeded our initial projections despite the challenges we discussed earlier. As we begin 2016, the fundamentals of Aetna's business remain strong, and we remain committed and confident we can close the Humana transaction in the second half of 2016 and that we can achieve our 2016 operating EPS projection of at least $7.75.

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

Thomas F. Cowhey - Vice President-Investor Relations

Thank you, Shawn. The Aetna management team is now ready for your questions. We ask that you limit yourself to one question so that as many individuals as possible have an opportunity to ask their question.

Operator, the first question, please.

Question-and-Answer Session

Operator

Our first question today is coming from Josh Raskin from Barclays. Please proceed with your question.

Joshua R. Raskin - Barclays Capital, Inc.

Wanted to drill down a little bit on the Government segment, obviously a bright spot for the year. So where do you see the pre-tax operating margins in the Government segment overall, and how should we think about the sustainability? And maybe is that what's playing into a little bit of an uptick in MLR and/ or the G&A ratio expectations for 2016?

Mark T. Bertolini - Chairman & Chief Executive Officer

Well, first of all, Josh, I think we think mid single digits is an appropriate margin for the Government business. We continue to see STAR ratings helping with that, as well as the level of effort we put into improving the quality of care, which ultimately drives down the medical costs in that segment. For the bridge on that, I think we could have Shawn talk to you a little bit about how we see it going from year to year. But we still see this segment as a very good segment, strong growth, and our ability to maintain mid single digit margins.

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Yeah, Josh, and so we've talked about elements of this, but this year, we – probably, the biggest movers have been on Medicare, have certainly been the individual MA business, where we've gotten into our mid single digit range probably about a year earlier than we previously had expected. We had a very good year in PDP and our continued strong performance in Group also maintained itself. I would envision that we will continue to be in the mid single digit range next year on Medicare. And on Medicaid, we have done exceptionally well. We've talked about the Kentucky rate reset. But when you strip PYD out in particular, I would expect these margins to be down a little bit, but still in a very good range overall and a range that I think that we can sustain going forward.

Joshua R. Raskin - Barclays Capital, Inc.

And so is that MLR increase for 2016 that you guys are expecting, is that just lack of PPRD in your estimates for 2016? Or – because it didn't sound like there were any changes in Commercial overall or Government overall.

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Well, again there's a little bit of, I would say, rate reset in the Medicare business on the Group business that tends to be experienced, rated and renewed, as I mentioned PDP, as well. So some of that is coming from there. The Kentucky rate reset also has an impact, but, obviously, PYD is a big piece of the commentary at that point. But there are a few, what I'd say sort of fundamental things that would be working that number up as well.

Joshua R. Raskin - Barclays Capital, Inc.

Okay. Thanks.

Operator

Thank you. Our next question today is coming from A.J. Rice from UBS. Please proceed with your question.

A.J. Rice - UBS Securities LLC

Thanks. Hi, everybody. I might focus in on the $0.40 to $0.45 benefit in the bridge from margin improvement in ACA businesses. I know there were some things like exiting in a particularly one market, but I think you exited a couple, and obviously repricing in some of the markets you stayed in that were important drivers in improving profitability and then there's some other things that you're just hoping in claims experience going forward. Can you give us some sense of how much you sort of already have in place and how much still remains to be seen of that $0.40 to $0.45?

Mark T. Bertolini - Chairman & Chief Executive Officer

A.J., we exited three markets, but one large one, Kansas, which was driving a big piece of our headwinds relative to margin in the public exchange, and then two smaller states and then we entered another state. So, net-net we're down two markets. The membership's going to be flattish for the year.

But I think as we ended the quarter and I can have Shawn take you through the numbers, as we ended the quarter, we saw some positive results coming out of settling out all of the risk pools and the CSRs and everything else as part of that. And so, we see some help in the fourth quarter results as they tailwind going into 2016.

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Yeah, A.J., so as Mark mentioned, I think the most important probably development in the quarter, as I think about next year, is the fact that, as we've gotten another quarter and a full year under our belt on Individual, that business for 2015 has probably gone from a mid single digit loss to a loss of three to four points. And that is a combination of looking at all of the factors that impact this business, which are substantial. But that that baseline is better going into next year is something that I think that makes us feel a lot better.

You're right. There are multiple things. We've talked about these before. The market exits were one of the pieces, obviously rate increases, medical cost initiatives, and we've made a substantial investment this year into doing better on risk adjusted revenue as well. The market exits certainly aren't the majority of that, but they are a meaningful piece of that improvement in a way as we talked about, there's somewhat of an insurance policy when we thought about this to at least make headway in this direction.

A.J. Rice - UBS Securities LLC

Okay. Great. Thanks a lot.

Operator

Thank you. Our next question today is coming from Kevin Fischbeck from Bank of America. Please proceed with your question.

Kevin Mark Fischbeck - Bank of America Merrill Lynch

Great. Thanks. I guess when you talk about just kind of continuing on that last question about the dynamics, you kind of lump Individual and small group into the same kind of bucket. Can you give us a sense of kind of what the breakout is between those two parts of the segment and are the improvements that you're seeing driven by the same dynamics or are they separate?

Mark T. Bertolini - Chairman & Chief Executive Officer

Yeah, the most marked improvement – and my commentary in the prior question was really directed more at Individual in terms of what emerged and what we saw – experienced in the quarter. The numbers happen to be the same, but they do come from a little bit different places. We have about a $3.5 billion block of Individual business at minus 3% to 4%. We are positioning that to try to get back to breakeven in that neighborhood. And then on the ACA small group, which I think had – the quarter was fine. It was a stable quarter for that business, that business is probably a lot closer to breakeven now. And we're looking to improve that business 300 basis points – 400 basis points next year. So, I think if you do that math, you'd get pretty much right on top of the numbers that are in our bridge of $0.40 to $0.45 coming out of those two blocks.

Kevin Mark Fischbeck - Bank of America Merrill Lynch

Is it the same thing to get there? Is it pricing and market exits? Or is there any difference there between the improvement?

Mark T. Bertolini - Chairman & Chief Executive Officer

Yeah I mean, the – obviously the risk adjustment element sort of crosses all ACA business, but rate increases are a part of that, on both fronts. We didn't really have any market exits of note on the small group business. So, – in a generic sense, yes, but this market exit phenomena has been more of an item for Individual.

Kevin Mark Fischbeck - Bank of America Merrill Lynch

Okay. Thanks.

Operator

Thank you. Our next question today is coming from Christine Arnold from Cowen & Company. Please proceed with your question.

Christine M. Arnold - Cowen & Co. LLC

Hi, there. Thanks for the question. Could you quantify some of these individual true-ups and does it change, kind of in seasonality? Is some of this related to prior quarters? Just so we can get the seasonality right for next year.

And also of the $0.40 of productivity gain, what are the drivers and how much of that's locked in and is there potential for upside or is there risk of downside? I have a hard time externally examining an SG&A savings expectation. Thanks.

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

On SG&A, again, this is something that we are constantly working on. And, again when – we do have some membership pressure in our ASC business, so we've had a lot of activity to sort of right size the organization in response to those changes. But as I've mentioned before, this is working to improve the productivity in our business. It's something that's very important, not only for the year to year financial elements and financial performance, but also sort of to continue to sort of generate the kinds of funds that we might need to invest in the business going forward and to put into potentially new categories of spending down the road. So, if you looked at the number in the bridge, that's probably on a net basis about a 30 or 40 basis point improvement in the SG&A ratio. And obviously it's something that we feel that we can achieve.

On the Individual business, there is always a lot of parts. And what I would tell you is that if on the revenue side, which the biggest moving part tends to be the risk adjustment that held steady. Actually our outlook improved a little bit on that one. Most of the improvement has been sort of in the underlying medical baseline and this was, as Mark mentioned, there's a number of things going on there. Just the claim development patterns, when you think about reserve estimation and all of the membership churn and sort of the emerging seasonality patterns, we've sort of updated our estimates there. Reinsurance, the cost sharing reduction payments, there's just a number of things there. One way to think about this, if you looked over this, if you look at our PYD change, we probably had about $0.10 of PYD on the Commercial business in the quarter and a good chunk of that was sort of truing up our estimates across some of this Individual business.

Christine M. Arnold - Cowen & Co. LLC

That PYD was related to the third quarter, right?

Mark T. Bertolini - Chairman & Chief Executive Officer

No, that would be – that's prior year. Anything else would've been (32:08).

Christine M. Arnold - Cowen & Co. LLC

Okay. Thank you.

Operator

Thank you. Our next question today is coming from Gary Taylor from JPMorgan. Please proceed with your question. Mr. Taylor, your line is now live. Please proceed with your question. Perhaps your phone is on mute. Please pick up your handset. Our next question today is coming from Peter Costa from Wells Fargo Securities. Please proceed with your question.

Peter Heinz Costa - Wells Fargo Securities LLC

Thanks for the question. If I look at your history of the medical cost trend guidance over the last few years, it's gone up by 75 basis points from 2013 to 2014 then another 75 basis points, 2014 to 2015. This year it's only up 50 basis points in the midpoint of your range.

What's the earnings risk if it ends up at the 75 basis points that it's been historically? And if I look at the guidance by component, the only real change from the components is that you've increased the waiting on pharmacy versus the waiting on physician, which you'd think would cause a faster trend increase.

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

I mean, I guess the direct answer to your question is you can simply do the math of 25 basis points on our commercial premium which is in the high $20s-billion. But again, we feel confident in our trend outlook for next year. Certainly in the past – again, this is our core Commercial business so a lot of the things we've talked about in Individual aren't at work here. But when we look at the kinds of things that are going on in the marketplace, we're comfortable that anticipating a 50 basis point at the midpoint uptick is reasonable. Again, it's a range, we have that range of 6% to 7% and we finish the year also in a very good position, so I continue to be comfortable with that outlook.

Peter Heinz Costa - Wells Fargo Securities LLC

So then at the 7% you would be below your earnings guidance? Is that correct, or at the 7% would you still be at your earnings guidance?

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Again, it's a range of estimates at this point. It's early in the year and I don't want to get down to being overly precise at this stage in the year.

Mark T. Bertolini - Chairman & Chief Executive Officer

Peter, our guidance is at least $7.75 so there's....

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Right. Our number is also an at least number.

Peter Heinz Costa - Wells Fargo Securities LLC

Okay, thank you very much.

Operator

Thank you. Our next question today is coming from Andy Schenker from Morgan Stanley. Please proceed with your question.

Andrew Schenker - Morgan Stanley & Co. LLC

Thanks. Good morning. I was actually hoping to understand a little bit more about the Commercial Insured membership guidance here. Obviously highlighted as a small group and international on the release, but how's large group trending? And then for small group it sounds like you continue to favor margins over membership here, but how should we think about small group in maybe potentially going forward here, how's the pricing environment? Are you still seeing dumping and are margins in small group now at a point where maybe heading into 2017, we can see a renewed focus on membership growth within that block? Thank you.

Mark T. Bertolini - Chairman & Chief Executive Officer

Andy, the market remains rational from a pricing standpoint. We don't see any unusual behavior, more so this year than in other years. So we see this as a rational environment. But Karen can give you some insights into how do we see the small group market evolving.

Karen S. Lynch - President

So, Andy, I think you know I just want to remind you that the small group market has been very dynamic. If you think about what's happened with history, we've had the keep what you had dynamic, we had the change in the 51 to 100. So it's been a very dynamic marketplace. We will continue to favor margin over membership in the small group market. As I said in the third quarter, we expect to see continued decline in volume pressure in our small group business throughout 2016. But as Mark said, the market is rational. We see competitive pricing across the board and we will continue to drive margin over membership, as I said before.

Andrew Schenker - Morgan Stanley & Co. LLC

Thanks.

Operator

Thank you. Our next question is coming from Gary Taylor from JPMorgan. Please proceed with your question.

Gary P. Taylor - JPMorgan Securities LLC

Hi. Sorry about the technical issue earlier. Just one clarification and then one question. When we look at the 3R in the fourth quarter versus your original expectations or your expectations back in the third quarter, it looks like those were roughly $93 million worse than expected, a smaller reinsurance receivable than expected, a larger risk adjustment payable than you had originally expected. And then you talk about positive – separately positive prior year development impacting the Individual business. So, are you saying that the improved performance and the positive prior year development more than offset the 3R such that the Individual business is actually a bigger contributor to earnings or I guess a smaller drag on earnings in the fourth quarter than you anticipated in the third?

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Yeah, I think you're conclusion is correct and that certainly the Individual performance was better than we had originally established. We can follow-up offline on some of the specifics, but certainly, reinsurance was one thing that looked a little bit worse in terms of the rate at which we accrued. And I mentioned earlier that risk adjustment was modestly better, actually, in terms of what we thought was going to happen there. And again, the important thing here is the underlying claim cost performance that also looked to be a little bit better. So net-net, that is a correct conclusion that that turned out to be a bit better than we thought coming into the fourth quarter.

Gary P. Taylor - JPMorgan Securities LLC

And on the prior year development in the Individual business, is that being driven by number of claims, cost of claims, estimates around special enrollment periods, enrollment levels, et cetera? Is there any way to tighten down what came in better than the original expectations?

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

I mean it's really about the aggregate level of claims. There's an awful lot of moving parts in this business. So inevitably, many of the elements you mentioned sort of play into the analysis, but it really is sort of about the underlying sort of claim costs that we're seeing supporting this business.

Gary P. Taylor - JPMorgan Securities LLC

Okay. Thank you.

Operator

Thank you. Our next question today is coming from Ana Gupte from Leerink Partners. Please proceed with your question.

Ana A. Gupte - Leerink Partners LLC

Yeah, thanks. Good morning. My question was about the Humana antitrust. I think you say that seven state approvals have been achieved. Can you give us some color on which states they were, and if these were contingent approvals, and if you had any color on divestitures?

Mark T. Bertolini - Chairman & Chief Executive Officer

Hi, Ana. We are not giving out the names of states. And although some are important states for us to get, none of them have been contentious. All of them have – all the hearings we have had have been very straightforward, supportive for the most part. We continue to see more approvals coming, and it's an extended process state-by-state. Some of these approvals are contingent upon Department of Justice approval, which is a norm for this. The DOJ conversations are not even yet started on the divestiture front. We're still sharing data and working on the framework of the discussions. And so that still is yet to come, but we anticipate that that won't be too far into the future here. And we still look at the second half of 2016 as an appropriate time to get it closed.

Ana A. Gupte - Leerink Partners LLC

And there was some news flow around the 15 states that have now joined up with the DOJ including Florida. Would you view that as a positive or negative or net neutral to the process?

Mark T. Bertolini - Chairman & Chief Executive Officer

That is actually standard in every deal we've done, where the Attorney Generals need to look at this information. They join in with the Department of Justice to get access to the same information. We actually negotiate the confidentiality agreements and get those signed, so it's all part of standard course of these kinds of transactions.

Ana A. Gupte - Leerink Partners LLC

Got it. Thank you.

Operator

Thank you. Our next question today is coming from Scott Fidel from Credit Suisse. Please proceed with your question.

Scott Fidel - Credit Suisse Securities (USA) LLC (Broker)

Thanks. Had a question just on the guidance for the Commercial ASO to be down around 750,000 lives. Just interested what the breakout is between the lives that you lose from the Assurant network access relationship going away as compared to other account losses. And then, just interested on the Assurant piece, how did the fields typically look on that network rental-type business as compared to classic Commercial ASO business?

Karen S. Lynch - President

Scott, it's Karen. So, I would say about 40% of that membership loss is Assurant. And the way to think about that is we provided network rental fees, very low PMPMs, high margins, but overall manageable results and not material generally.

Scott Fidel - Credit Suisse Securities (USA) LLC (Broker)

Got it. And then just one quick follow-up. Just on the Humana deal, just interested if are you still seeing all the accretion targets the same as in the prior guidance or any updated thinking there just along the lines of either Humana's business performance or some of the recent changes in the bond market. Thanks.

Mark T. Bertolini - Chairman & Chief Executive Officer

We've started, but I'll save the bond market piece for last. We can have maybe Shawn comment on that, but – which is actually I think good news so far that you'll keep following. But I think relative to the transaction, we continue – we have a joint integration operating committee that meets to the degree we can meet. We've started to work on culture between the organizations because culture turns strategy and we want to make sure we bring these organizations together effectively to best-of-breed strategy.

We continue to pour over all the potential accretion opportunities in both organizations as we get to know more within the limits of what we're allowed to look at. And I can say that we do have internal targets, which always are a little more aggressive than what we share with all of you, which is the appropriate way to manage these kinds of things so that we make sure that we deliver.

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Scott, in terms of the deal financing, it's far too early especially in this market to declare victory there. But certainly, what's happened heretofore, I think we still feel good about our financing assumptions. It is both a rate and spread dynamic and those have obviously held so far in terms of what we have assumed. So, we still have some time to go here and as we've seen, these things can move around a little bit, but we still feel good about the assumptions that we gave you.

Scott Fidel - Credit Suisse Securities (USA) LLC (Broker)

Okay, thanks.

Operator

Thank you. Our next question today is coming from Matthew Borsch from Goldman Sachs. Please proceed with your question.

Matthew Borsch - Goldman Sachs & Co.

Yes. Let me ask a question on the Medicare Advantage business, if I could. As you look forward to 2017 with the HIF suspension, how do you plan on handling that tailwind, if you will? I mean, given that the various combinations of things that – if it's a tailwind, and we don't know what the 2017 rates are yet, but how much of that would you anticipate plowing the benefits, capturing, et cetera?

Mark T. Bertolini - Chairman & Chief Executive Officer

Well, I think, Matt, that all depends on how the market reacts in each segment. So as we look at the HIF relief, it's not really all relief. There's a lot of work behind that. For example, on the Medicaid relationships we have, those are separately negotiated. So there obviously will be a conversation there with our employer clients already asking about how does that affect pricing, how do they want to handle it in pricing, and with Medicare, how they set rates.

And so, we view this as not a windfall by any way, shape or form, but something that's going to be delicate to manage because unless it's extended, which we highly doubt, this is going to be a difficult transition going in and out. As you know, we spent a lot of time getting the fees into rates, so having them come out and go back in would be difficult. So I would say more to come. We have a team working on this. We've had a couple of reviews already of the potential strategies we could pursue, but we're not quite ready to declare victory or defeat on either side of this yet.

Matthew Borsch - Goldman Sachs & Co.

All right. Thank you.

Operator

Thank you. Our next question today is coming from Dave Windley from Jefferies. Please proceed with your question.

David Howard Windley - Jefferies LLC

Hi. Good morning. This is in regard to the transaction, is your plan, Mark, still to have the Government side of the combined entity, assuming it does close, run out of Louisville and by the Humana team? Well, I'll stop there. Is that still your plan?

Mark T. Bertolini - Chairman & Chief Executive Officer

Our plan is that Louisville will be the headquarters for our Government business which will include Medicare, Medicaid and TRICARE. And so that is the commitment we made in the merger agreement. That is the commitment I just made in front of the Greater Louisville Inc. Chamber of Commerce last Monday evening or last Tuesday evening in Louisville and something – is actually the only community where we've made a real estate commitment as it relates to putting these deals together.

David Howard Windley - Jefferies LLC

Got you. And then, in terms of Humana's largest segment and the leadership there, there's been some turnover. Is that a concern to you? Is it something that you can have any influence over at this point? I'm guessing the answer is no there. I'm just interested in your views of stability of leadership in the Humana individual – or in the Humana Retail segment, both for kind of managing bids for the upcoming bid for the 2017 period, which you'll care more about, and for the leadership of the combined when that happens?

Mark T. Bertolini - Chairman & Chief Executive Officer

I realize all the leadership decisions, operating model, management process are still to be defined. I mean, they're still a competitor and so we don't have the kind of visibility or command of that organization to make those decisions. I do know that within the context of the deal, there are stay bonuses in place for people that are key to the ongoing operation of the business, and we approve those as part of the merger agreement going forward. And Bruce and I are in constant conversation about this and making sure that we're keeping the people we need to keep.

David Howard Windley - Jefferies LLC

Okay. Thanks.

Operator

Thank you. Our next question is coming from Chris Rigg from Susquehanna Financial Group. Please proceed with your question.

Chris Rigg - Susquehanna Financial Group LLLP

Hi. Good morning. Just wanted to come back to the ACA-compliant business again. The improvement that you're expecting in 2016, is it right to assume that most of that is all due to Aetna-specific actions? Or are some of the changes to special enrollment period or further refinements to the risk-adjustment program factoring in so there's more of a macro benefit as well? Or is it simply just stuff that you've done? Thanks.

Mark T. Bertolini - Chairman & Chief Executive Officer

I think for now it's stuff that we have done. We are providing detailed information and data to CMS based on what we've experienced as our data set. As you know, the operational accounting for – of the HIX is not quite up and running yet. So, they're running a bit blind as it comes to data and so we're sharing our data with them, giving them insights. It's part of what's gone into the feedback around special enrollment period, the three Rs, and a host of other issues that we think are important to get addressed to stabilize this program going forward.

The changes made to date are necessary but not sufficient and we need to do more over time to make this program stable and supportive. I mean, there are two ways this program can go. It can be a Medicaid plus kind of program with a high risk pool on a national basis versus a local basis to try and support a population of folks that are below 400% of the Federal Poverty Level. Or, we can shape the program to get a wider risk pool and a more stable risk pool that encourages healthier risks to come in and allows us to have a broader range of population in the program. That's yet to be decided and will be based on the kind of changes we make going forward.

Chris Rigg - Susquehanna Financial Group LLLP

Great. Thanks a lot.

Operator

Thank you. Our next question today is coming from Tom Carroll from Stifel. Please proceed with your question.

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

Hey, guys. Good morning. I wanted your thoughts on the upcoming release of the Medicare Advantage rates for 2017. And in particular, I guess less on the rates and more on policy changes that may influence your view of becoming a much bigger player in the Medicare Advantage world, specifically risk adjustment recalibrations. So any thoughts have you there. Thanks.

Mark T. Bertolini - Chairman & Chief Executive Officer

Well, I think the place to start is at a number of years ago, probably three years ago when we had a big rate reset, we had a conversation with the administration, with CMS, that said, listen, we want to get to 100% of Medicare fee-for-service as an appropriate rate structure, but we want to do that over time so that responsibly, we do not adversely impact the Medicare beneficiaries, and that has been our goal all along and we continue to work toward that. And I think the last couple of years have demonstrated a better partnership in coming to conclusion around that.

Part of the noise that you'll in this is you had the earlier release from the actuaries, which is just one input. Then you'll have the February notice, which will be another set of what I would call the smorgasbord of issues that we want to talk about as we come forward with an ultimate solution that will make itself readily apparent in April.

I think the industry, both through AHIP and Better Medicare Alliance, has focused on making sure that all issues are understood, that everybody is sensitized to the impact on the beneficiary ultimately, and that we come to a conclusion that allows the program to continue to grow. Because we believe that Medicare Advantage in the long run at the right rate structure is the appropriate solution for solving some of our entitlement programs, particularly around the Medicare population.

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

Just as a follow-up on the risk adjustment in particular, do you think that could end up being a good guy or a bad guy relative to the Aetna MA book and perhaps even – I know it's early to talk about Humana, but on the Humana book as well? Maybe some thoughts there, just get the conversation out of the way.

Mark T. Bertolini - Chairman & Chief Executive Officer

Well, the risk adjusters in and of themselves are a set of numbers that you have to manage against, which means you have to find the information, you have to work on actually improving the quality of care so that it makes the risk adjusters work. And so, part of what we're going to see as we go forward is that the Medicare fee-for-service 100% number is going to continue to drift down as the industry does a better and better job of taking people with chronic comorbidities and managing them more effectively by improving the quality of care. And it's through that change over time that you'll see sort of two glide paths drifting down, the industry's rate structure drifting down on top of that 100% of Medicare fee-for-service. Risk adjusters is just one part of that, and those risk adjusters will change as we improve the quality of care and the underlying health of the Medicare population.

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

Great. Thanks, Mark.

Operator

Thank you. Our next question today is coming from Brian Wright from Sterne Agee. Please proceed with your question.

Brian Michael Wright - Sterne Agee CRT

Thanks. Good morning. Have a real quick philosophical question and then a detailed. So, just from a perspective, this year's guidance was, at least originally, at least $6.90. Did you barely beat it at the $7.04 on a baseline or did you really crush it at $7.71?

Mark T. Bertolini - Chairman & Chief Executive Officer

I guess that's up to you.

Brian Michael Wright - Sterne Agee CRT

There's no – you don't have a horse in this race?

Mark T. Bertolini - Chairman & Chief Executive Officer

Of course, we have a horse in the race and, of course, we perform and we always want to deliver. And then our belief this is a very solid performance, 15% year-over-year. I mean, it's...

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Yeah. Don't over-complicate it. 15% EPS growth in a year where we're really limited on share repurchase. We had a very good year.

Brian Michael Wright - Sterne Agee CRT

Okay. Thank you. And then just on – thanks for that and that perspective. Just on a detailed question, the reserves have looked good all year, but you have the ICD-10 kind of impact on the fourth quarter. Did that have any material impact on DCPs or were medical clients favorable in the quarter?

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Well, it's certainly an issue that we have watched carefully during the quarter. We have not really seen any meaningful disruption as a result of ICD-10, and I suppose that is one of the silver linings of having a long time to get ready for this as a broader industry. But it is something that we are definitely paying attention to carefully throughout the quarter and frankly even into the beginning of this year as well.

Brian Michael Wright - Sterne Agee CRT

And so far, everything is – it looks like you thought it was.

Mark T. Bertolini - Chairman & Chief Executive Officer

Yeah. What we're doing, Brian, is we're running parallel views to see whether or not there's any gaining going on between ICD-9 and ICD-10. And so far, we don't see that between the CPT-4s because we're worried about that. But we worked with a number of hospital systems and provider partners to do this check to make sure that there wasn't anything adverse coming out of it, and so far so good.

Brian Michael Wright - Sterne Agee CRT

Great. Thank you so much.

Operator

Thank you. Our next question today is coming from Michael Baker from Raymond James. Please proceed with your question.

Michael J. Baker - Raymond James & Associates, Inc.

Yeah, thanks a lot. Mark, I was wondering since we didn't get the Investor Day, certainly understand why. If you could update us on your thoughts around private exchanges and what levers might have to happen in order to increase interest around that by employers? And then, as you were driving towards your $10-plus in 2018, what other kind of factors or offsets, since you have a multi-faceted business like Government, should we think about as we think about that trajectory overall?

Mark T. Bertolini - Chairman & Chief Executive Officer

Well, I think first on private exchanges, we're seeing the slowdown we anticipated as a result of employers who have tried it, but didn't see the rate stability that they want to see and have pulled back, particularly on the fully insured segments and moved back to ASO. And so, that's a sign that there need to be better proof points. And we are launching our own private exchange version – proprietary private exchange version in a number of markets. Small group this year, we started already and we have some clients for 2016 – or actually 2015, I'm sorry. And then 2016, we have some clients that will be trying out our product and will be launching a Medicare version of private exchange as well for 2017.

And so, we see a lot of importance in connecting the underlying networking cost structure of healthcare to the private exchange in order to provide the stability that employers need and retail customers need in order to buy from us through that kind of model. And so that has not been proven yet and so you're seeing it slow down to a degree until people start to put proof points out there that work. So I think that is something that we need to be keeping our eye on.

Now, if you look back at our guidance on the $10, there was not a lot of reliance on private exchange growth for that to happen. We see the government sector as a key driver of that growth opportunity as we continue to grow individual Medicare Advantage, continue to grow group interestingly enough year-over-year and as we watch PDP last year profitable, this year growth, and what we believe to be an appropriately-priced segment. So, we see the government sector as a driver of that going forward. And we believe that if we get the HIX right, that that will be a contributor going forward as well.

Michael J. Baker - Raymond James & Associates, Inc.

That's helpful. Then on another topic, hearing that in terms of negotiations with pharma that outcomes is becoming much more important in how those dollars flow, are we going to see any meaningful impact there? Or is this inning number one of the ball game, so to speak?

Mark T. Bertolini - Chairman & Chief Executive Officer

Well, I think it's inning number one because just talking about outcomes is an amorphous conversation. The conversation with pharma that we're having needs to be much more specific. It needs to be, what are you going to do to make sure that the drug you're supplying not only has the right outcome, but gets the right level of compliance by the end user in order to control the quality of care that that end user gets? And my argument has been with pharma has been, it shouldn't be about the number of pills you sell; it should be about whether or not the people that are getting the pills are the right people getting full compliance, getting an overall medical cost impact that in the end analysis in sharing that risk with us, you get a better margin than just selling more pills. It helps them change the distribution model and allows us to go directly to the patient into the home where we believe we can get the ultimate improvement in quality of care and compliance.

Michael J. Baker - Raymond James & Associates, Inc.

Thanks a lot for the updates.

Mark T. Bertolini - Chairman & Chief Executive Officer

Yeah.

Operator

Thank you. Our final question today is coming from the line of Frank Morgan from RBC Capital Markets. Please proceed with your question.

Frank Morgan - RBC Capital Markets LLC

Good morning. I wanted to follow up on the special enrollment period, some of the changes that had been made. I think I noted you said that they were necessary but not sufficient. I'm wondering, could you quantify to say that are these enough – the changes so far, are they enough to actually move the needle in terms of your financial outlook? And if not, what are the changes that need to be made and which ones in terms of magnitude would have the biggest impact? Thank you.

Shawn M. Guertin - EVP, Chief Financial & Enterprise Risk Officer

Consistent with our discussion before about that our outlook is really premised on the actions that we've taken and we've controlled, I think I would have to answer the question no, that they have not been sufficient to change our outlook. That is not to diminish that directionally. They're clearly the right things to do, but there is just a number of sort of administrative and I think enforcement aspects around the special enrollment period that we would like to see get built out and implemented over time.

Thomas F. Cowhey - Vice President-Investor Relations

Thanks, Frank.

Thomas F. Cowhey - Vice President-Investor Relations

A transcript of the prepared portion of this call will be posted shortly on the Investor Information section of aetna.com where you can also find a copy of our updated guidance summary containing details of our guidance metrics, including those that were unchanged or not discussed on this call.

If you have any questions about matters discussed this morning, please feel free to call me or Joe Krocheski in the Investor Relations office. Thank you for joining us this morning.

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