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Aetna, Inc. (NYSE:AET)

Q2 2007 Earnings Call

July 26, 2007

Executives

Teresa Jhouka - Director of IR.

Ron Williams - Chairman & CEO.

Mark Bertolini - President

Joseph Zubretsky - EVP & CFO

Analysts

William Georges - J.P. Morgan

Scott Fidel - Deutsche Bank

Charles Boorady - Citigroup

Josh Raskin - Lehman Brothers

Al Copersino - META

Peter Costa - FTN Midwest Securities

Christine Arnold - Morgan Stanley

John Rex - Bear Stearns

Doug Simpson - Merrill Lynch

Presentation

Operator

Good morning and thank you for joining Aetna’s Second Quarter 2007 Earnings Call and webcast. As a reminder today’s call is being recorded.

Teresa Jhouka

This is Teresa Jhouka (ph), Director of Investor Relations for Aetna. During the 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 expected results are described in our 2006 10-K filed with the SEC.

Pursuant to SEC Regulation G, we have provided reconciliation of metrics relating to the company’s performance that are non-GAAP measures in our second quarter 2007 Press Release, second quarter 2007 Financial Supplement, and our 2007 Guidance Summary.

These reconciliations are available on the investor information portion of the Aetna.com website. Also, as you know, Regulation FD limits our ability to respond to certain inquiries from investors and analysts in non-public forums, so we invite you to ask all questions of a material nature on this call.

I would now like to turn the call over to Chairman and Chief Executive Officer Ron Williams.

Ron Williams

Good morning and thanks all of you for joining us on this mornings call. With me this mornings are Mark Bertolini, newel appointed President of Aetna and Joe Zubretsky, Executive Vice President and Chief Financial Officer.

Following my remarks Joe will discuss some of the details of our financial performance for the quarter. After, which Mark, Joe and I will be pleased to respond to your questions. I am very pleased with our performance in the second quarter across all dimensions of your business.

We are reporting operating earnings per share in the second quarter of 2007 of $0.83, an increase of 28% compared to the second quarter of 2006 and $0.04 per share above our guidance for the quarter.

This result reflects solid top-line growth achieved through our market segmentation strategy. Solid underwriting results driven by discipline pricing actions and favorable medical cost experience, as well as continued operating expense efficiencies derive form our cost management discipline.

Our increase in profitability reflects that we are serving more members and as a result of continued expansion through our segmentation and diversification efforts across more employee responses and government programs.

We also too some important strategic steps during the quarter to further position Aetna for growth in the future, which I will discuss in a moment.

The corners stones of our strategy to produce sustainable profit for earnings growth remain segmentation, integration, consumerism and operating excellence. And our design to position Aetna as an industry leader. I would discuss our second quarter performance across these four dimensions.

First, our efforts in the area of customer and market segmentation allow us to both diversify our revenue base and effectively execute in new segments of the market. We continue to create preferring to the marketplace by offering differentiated products and services and as a result we have very please with a net medical membership growth of 64,000 we achieved in the quarter. This brings our year-to-date growth to 334,000 member and 15.8 million medical members at the end of the second quarter.

During the quarter, we’ve also continued market expansion efforts in our individual small group and middle market operations. In our advantage plan individual products, we’ve extended into thee additional states. In addition, in national accounts we are very pleased with some early wins and the level of proposal activity remaining in our pipeline relating to the 2008 selling season.

We are actively working with large employers through our human resources policy association endorsement to offer healthcare coverage to their retiree population and the pipeline of prospects will certainly benefit our 2008 growth. But perhaps, our most significant accomplishment in the area of customer segmentation in this quarter was the announcement of the strategic acquisition of Schaller Anderson a leading provider of healthcare management services for Medicaid plans.

Upon closing this acquisition, we will position at Novel as a significant player in the Medicaid market and give us in additional avenue for profitable growth. Schaller Anderson has full operational capabilities to serve this important market and is recognized as a premier provider of medical management services with more than 20 years of experience working with Medicaid population. It has and its acquisition strategy by diversifying our product offering improving our local market presence in state in federal programs and strengthening our ability to improve quality and manage medical cost.

Next, integration of our products and services to deliver a strong value proposition to our customers is another important dimension of our long-term leadership strategy. Our customers recognized the value of our innovative solutions and integrated product offering that addressed their needs. By integrating medical, pharmacy, dental and behavioral health along with our leading active health medical management capabilities we are better positioned to manage medical cost while improving the quality healthcare.

As testimony to our integration strategy in the second quarter we continued to generate membership gains in our specialty products. Pharmacy membership increased by 90,000 in the second quarter, behavioral health membership increased by 54,000 and commercial dental ensure in ASC membership was relatively stable. Both our pharmacy and behavioral health penetration rates have been increasing and we are encouraged by the cost sale and revenue growth opportunities that are specialty products offered. In fact over 80% of our corporate customers have two or more products with Aetna. We believe that our integrated medical management approach continues to provide a differentiating value proposition in the marketplace and enhances our overall growth opportunities.

Our innovative approach to medical management under Aetna health connections takes a unique, holistic view of each covered member. Incorporating health status, benefit plan design, demographics, personal preferences and other information to help people understand and engage in attaining optimal health. Our proprietary active Healthcare engine has enabled to roll out of the sophisticated integrated products.

Membership for active health was 14.9 million at the end of the second quarter, an increase of 12% from June 30th, 2006. The third strategic dimension (ph) consumerism continues to be an important facet of our strategy. Our commitment to help provide consumers with access to better information about quality and affordable Healthcare services is demonstrated in our innovative products and services, as well, as our self service tools and capabilities. Interest in and adoption of these products and services by employers remain strong has evidenced this quarter by our consumer directed Heathcare membership reaching 960,000 members and the continued geographical expansion of our excel performance based network to four new markets affective January 1st, 2008 bringing the total number of markets to 35.

Reinforcing Aetna’s leadership position in consumerism, we have taken in active role and important policy discussions. I have actively worked with key business groups, Congress, Governors and State legislatures across the nation to continue to drive to provide transparent and useful information to consumers. Aetna is also committed to planning an active role in advancing Healthcare access and affordability. As I said in a recent Washington post opinion editorial piece, we hope that politicians and the public recognized that providing access to care that has proven effective and efficient is going to be critical to meaningful reform and then Aetna has real expertise to bring to the table.

Finally, the force to mention our strategy is operational excellence, which is embedded in everything we do. The three key financial metrics that does demonstrate our operational record and accomplishments along the strategic dimension are medical benefit ratio, operating expense ratio and pre-tax operating margin.

For the second quarter, our commercial medical benefit ratio of was 80.5% reflect solid underwriting discipline in our focused efforts in the area of medical management. This is an excellent result even after taking into account the higher seasonal utilisation in the second quarter. Importantly we view the medical cost environment is stable and we continue project our medical cost trend at 7.5% plus or minus 50 basis points for the year.

Operating efficiency continues to improve as demonstrated by the 60 basis point decline and our operating expense ratio to 17.8% in the second quarter of 2007 compared to the prior year quarter.

We have demonstrated consistent progress on reducing our cost as a percentage of revenue despite significant investments to profitably grow our business and enhance our technology infrastructure.

We will continue to proactively take actions to improve operating efficiencies going forward. The combination of solid underwriting results and operating efficiency lead to an excellent pre-tax operating margin of 10.8%, which bolts well for our full year expectation of operating margins being stable to slightly higher than 2006.

In conclusion, I’m very pleased with the results of the second quarter and the excellent market place success we continue to realize. I’m confident in our ability to continue to deliver top tier performance while successfully meeting customer needs for the balance of 2007 and in 2008 and beyond.

We now, project our full year operating earnings per share to be $3.40 to $3.42 an increase from our prior guidance of $3.35 per share. As a result of our continuing strategic efforts to diversify and expand our opportunities for profitable growth, I believe that Aetna is very well positioned to continue to sustain long term operating earnings per share growth of 15%. My sincere thanks to our dedicated employees who remained focused on expertly serving our customers and executing the fundaments of our business as we pursue our long term leadership strategy.

Now I will turn the call over to Joseph Zubretsky, who will discuss our financial performance for second quarter and provide our outlook for the remainder of the year. Joe?

Joseph Zubretsky

Thank you, Ron and good morning. Earlier this morning we reported after tax operating earnings of $439.8 million for the second quarter of 2007 or $0.83 per diluted common share. This compares to $377.1 million or $0.65 per diluted common share in the second quarter of 2006 increases of 17% and 28% respectively.

Operating earnings from our three reporting segments were $467.6 million of 17% increase over the prior year. Net income of $451.3 million includes an after tax benefit of $41.8 million due to reserves released resulting from our annual review of Large Case Pensions discontinued products reserve adequacy as well as $30.3 million of the after tax realized capital losses reflecting interest rate related market value adjustments on a portion of our investment portfolio.

Our diluted weighted average share account of 531.8 million shares was lower than our guidance of 536 million shares and represents a 9% decrease as compared to the prior year quarter due to continued strong share repurchase activity. For the quarter, healthcare segment reported operating earnings were $420 million representing an increase of 19% over the second quarter of 2006 driven mainly by our commercial medical benefit ratio of 80.5% which came in at the favorable end of our expected range.

Group Insurance segment operating earnings of $39.2 million were 9% higher than the prior year quarter and the Large Case Pensions segment operating earnings were $8.4 million which is 70% lower than the second quarter of 2006 due to lower investment income. Net investment income for our healthcare and Group Insurance segments was higher this quarter as a result of an increase in investments due to the growth in the business and higher yields. I will organize my comments on the second quarter results by the key drivers of our financial performance. First, managing to our target margins, second investing in profitable growth and third creating excess capital and deploying it accretively.

Let me first address our operating margin performance in the second quarter of 2007 and its key components, revenue, healthcare cost trend and operating expenses. As Ron mentioned the combination of solid underwriting results and improved operating efficiency led to expansion of our pre tax operating margin in the second quarter of 2007. The $439.8 million of after tax operating earnings or $670.9 million on a pre tax basis represent a pre tax operating margin and consolidated revenue of 10.8%.

This is an excellent result demonstrating management discipline across all aspects of our business including pricing winner, healthcare cost management and operating expenses control. Consolidated revenues increase 9% in the quarter from $6.3 billion in 2006 to $6.8 billion in 2007 with healthcare segment revenues increasing 10% year-over-year.

Premium is in our healthcare segment increased by 11% year-over-year with our commercial premium increasing by 6.3% and our Medicare premiums increasing by 55%. Specifically, the increase in premiums in our commercial products was primarily the result of higher rates to discipline pricing actions which given our reported commercial medical benefit ratio, general in line with the medical cost trend as well as year-over-year increases in membership. This rate in volume driven premium growth was moderated by the affect of product mix due to stronger than average growth in customer segments with premiums per member lower than the average for the broker business.

In our Medicare and Medicaid operations, year-over-year premium growth was fueled primarily by a 54% increase in Medicare Insured membership over last year’s second quarter, generated primarily from the membership gains in the first quarter 2007, as we realized the benefits of our previous investments and expanding our Medicare footprint.

Additionally, our second quarter 2007 consolidated fees and other revenue of $736.2 million increased 3% over the second quarter 2006. It was driven primarily by a combination of membership increases and slightly higher per member per month fees.

All in all, we view the premium pricing environment as stable and rational. Although, the market is competitive customers understand the underlying cost trends have moderated those trends with benefit design changes and have accepted premium increases that keep pace with the cost associated with quality healthcare.

Next, I will discuss the healthcare cost experience in the second quarter of 2007. The commercial medical benefit ratio was 80.5% in the quarter, which compares to 81.1% in the second quarter of 2006. Our total medical benefit ratio, which includes our commercial Medicare and Medicaid products, was 81.5% in the second quarter of 2007, compared to 81.9% in the prior year quarter.

To draw a more appropriate year-over-year comparison however, we remind you that with the benefit of (inaudible) our commercial medical benefit ratio for the second quarter of 2006 has settled at approximately 80.5% and our total medical benefit ratio of the second quarter 2006 has settled at approximately 81%.

These positive results are the direct outcome of our pricing discipline and our continued commitment to managing medical cost utilization to our dedicated medical management processes. With medical benefit ratio level also demonstrate that we have kept our pricing in line with medical cost trend. Our full year view of medical cost trend is that it is stable and consistent with our prior quarter guidance of 7.5% plus or minus 50 basis points.

Major healthcare cost categories continued to be in line with our expectations with inpatient costs trending at mid to high single-digit growth rates, outpatient at high single-digit, low double-digit rates and physician in pharmacy at mid single-digit growth rates.

Our utilization metrics continue to demonstrate our utilization management excellence, as our commercial bed days have decreased slightly year-over-year. We continue to drive the efficient unit price in to our networks as evidence by our recently announced national long-term hospital agreement with Tenet Healthcare, which provide a Tenet with the benefit of volume in facilities which have capacity and provided us with the benefit of better overall unit cost.

Additionally in a valuating healthcare cost results for the second quarter of 2007 it is important to note that prior period reserved development was not material. Our reserving practices remain consistent and appropriate and we ended the quarter with a prudent level of reserve adequacy. Our healthcare cost reserves increased by $32.4 million for March 31st 2007 to $2.2 billion at June 30th and days claims payable were marginally down 0.8 days to 45.4 days for the second quarter consistent with our with expectations.

Third in terms of our operating expenses for the second quarter of 2007, we continue to realize expense efficiencies that we reported in operating expense ratio of 17.8% representing a 60 basis point improvement compared to the prior year quarter. We continue to leverage our fixed cost by growing revenue in core markets and products continuing to drive down unit cost with technology and business process improvement all while making investments in our future growth to do product platforms, market expansions and new system capabilities.

With continued cost control in future growth we remain comfortable with our targeted 100 basis point improvement and the operating expense ratio from 2006 to 2007.

I would now like to comment on our growth prospects including more detail on our second quarter membership growth. During the quarter we grew our medical membership by 64,000 members to approximately 15.8 million members at June 30th. Specifically of the 64,000 approximately 39,000 were insured members and 25,000 were self-insured or ASC members.

With respect to insured membership, we continue to realize meaningful growth from our select account customer market, our individual markets and our group and individual Medicare advantage products. We respect to ASC membership, our key account customer market made a meaningful contribution to membership growth this quarter.

These results illustrate the marketplace traction we continue to gain and as a result of Aetna’s brand awareness. Our strong direct to consumer strategy in the effective execution of our group and individual Medicare strategies. We are please with our continued membership growth and are confident that our diversified market opportunities we got our additional members in the second half of 2007 consistent with our guidance.

It will still too early to provide guidance on January 2008 membership growth. We remain optimistic that we can grow profitably in 2008 by realizing the benefits of the initiatives we have launched in 2007. Our commercial local market initiatives are retiree product affinity relationships with the human resource policy association and AARP are expanded Medicaid presence through Schaller Anderson and good traction in generating GASB (ph) driven Private Fee-For-Service opportunities in the government sector all signal a strong start to 2008.

Finally, the third areas of financial performance I will comment on is our management of capital and as accretive deployment including our cash flow dynamics, our holding company liquidity, how we deploy that liquidity in the quarter and our capital structure.

Our second quarter 2007, operating cash flow measure on a GAAP basis for Health Care and Group Insurance was $396.9 million which approximates to level of GAAP net income for the quarter inline with our expectations and on course to achieve 120% to 130% for the full year. Our business continues to have excellent cash flow velocity. In the second quarter we generated $523 million of holding company cash flow, which combined with our March 31st liquidity position of $167 million resulted in $690 million being available for investment in acquisitions or share repurchases.

During the second quarter, our primary use of holding company liquidity was to repurchase our own shares. In the quarter, we repurchased 6 million shares in the open market for $303 million using $175 million of holding company cash and $128 million of proceeds from exercised options. Our basic share count is now 511 million shares at June 30th, down slightly from 512 million at March 31st. Therefore at the end of the second quarter we maintained $515 million of holding company liquidity. As we soon expect regulatory approvals to close the Schaller Anderson acquisition, this liquidity position is currently air marked to finance it.

Our capital position is solid, with a total debt to total capitalization ratio of 20.2% well below our targeted 25%. We are strongly considering taking additional capital actions to optimism our capital structure, which could include a first step of managing toward 25% total debt to total capitalization by the end of this year. Proceeds from any securities issuance would be used for share repurchases and other capital needs including acquisitions. This plan would likely be executed later up in the year such that it would accretively impact 2008 earnings per share rather than 2007. This will serve to reduce our weighted average cost of capital, enhance returns on common equity and diversify our funding sources.

Regarding capital deployment our priorities continued to be to finance organic growth to seek and finance strategic acquisitions and to repurchase our own shares. We continue to maintain an active M&A pipeline and our acquisition discipline is focused on enhancing our operational and product capabilities, managing medical cost and improving quality and expanding our market breadth consistent with our strategic objectives of local market density, medical cost management, innovation and customer market segmentations. Schaller Anderson is an excellent example of fulfilling the strategic intent. We are excited by the prospects of having a robust Medicaid platform to serve the uninsured. This acquisition will add approximately 600,000 Medicaid members in over $600 million of profitable revenue. Ones fully integrated, we expect the acquisition to accretive by approximately $0.03 per share before realizing any potential for additional growth.

Before we move to the Q&A session, I would like to provide some guidance for the remainder of the year. Given another solid quarterly performance, we have increased confidence on our ability to sustain our level of performance for the remainder of the year. To be specific we project a medical cost trend of 7.5 plus or minus 50 basis points, a premium yield that is in line with medical cost trend, a commercial medical benefit ratio for the full year 2007 now less than 80% with a total medical benefit ratio of less than 81%. An operating expense ratio showing approximately 100 basis points of improvements over the 2006 level, a pre-tax operating margin that is stable slightly higher than 2006 and full year operating earnings per share in the range of $3.40 to $3.42 which is based on 532 million diluted weighted average share count.

In addition, we are projecting our third quarter operating earnings per share on the range of $0.90 to $0.92 in the commercial medical benefit ratio to be in the range of 79% to 79.5%. Our fourth quarter operating earnings per share will reflect cost associated with the anticipated operational ramp up for January 2008 membership.

With respect to growth, we are maintaining our prior guidance of double-digit healthcare revenue growth. In addition, we are maintaining our medical membership growth guidance at 575,000 to 600,000 net new members. Our strategy continues to open new market opportunities and we are confident in our ability to continue our growth throughout 2007 and into 2008, through our vigorous focus on profitable growth are remain confident and our ability to achieve the high level of financial performance we have projected.

Now, we’ll open the phone lines for questions and answers. Operator?

Question-and-Answer Session

Operator

Yes, we’ll take our first question from Bill Georges of J.P. Morgan.

William Georges - J.P. Morgan

Hi, good morning. I’m wondering if you could give just a little more detail you just touched on the earnings patterns but I guess as a fourth quarters it imply to be down sequentially from the third quarter. Could you give us just a little more color on your guidance there in seasonality?

Ron Williams

Yes, Good morning Bill. I’ll ask Gell to give you some more color on that.

Mark Bertolini

Yes Bill, as implied by our guidance for $0.90 to $0.92 per share in the third quarter that would imply that $3.40 to $3.42 and fourth quarter would be an $0.86 quarter. If it seasonality in our MBR certainly pleasant to it little bit, for a little bit but primarily we are projecting additional SG&A cost in the fourth quarter compared to the third to ramp up for 2008 membership. Certainly, we are keeping our eye on how much membership we expect to gain from 110A and the level of spending in the fourth quarter would be commencer with that ramp up, but right now we’re projecting that to occur.

William Georges - J.P. Morgan

Any early read on '08 membership?

Ron Williams

Yes, the ’08 membership activity has been focused on national account and then I ask Mark to give you some color. I would say that we’ve been very active in the market. I know I’ve spend a lot of time in finalize meetings and discussions with clients. Mark, has as well known as him to give you an update.

Mark Bertolini

Sure Bill. And we’ve actually seen an increase in our proposal activity over last year, on a year-over-year basis. Our close ratios are too early to tell, although they look promising so far.

So, we, I’m in the national account sector believe that we will have, we are comfortable with our memberships coming out for the first year.

William Georges - J.P. Morgan

Great. Thanks very much.

Joseph Zubretsky

I think maybe one other point I’d make Bill, is that the relationships we’ve had the Human Resource Policy Association has been a real positive in terms of generating activity.

The solutions clearly aren’t necessarily right for every company, everyone of the 250 companies in that group. But we’ve had very strong interest and are in a very significant discussions with clients about how those solutions work for them.

Operator

We’ll take our next question from Matthew Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs

Yes. Thank you, good morning. Could you just talk to growth in the individual market, maybe some indications of how much of the growth this quarter was from that segment?

And, I’m trying to tie back the growth that you’re seeing there, a little bit comments from a competitor of yours yesterday, that they were seeing new competition in some of their individuals segments, gather in California and part they didn’t necessarily characterize that as price driven.

But, I am just wondering if you could comment on how you think you’re gaining market share there?

Joseph Zubretsky

I would start off by saying that, our individual product has been a huge success for us. We have a great brand and the familiarity that we have in the market place is the result of the corporate business positions us very well along with our networks and presence. And I’ll ask Mark to give you more detail on that.

Mark Bertolini

A few comments Mat. I would say that about 35% of our growth in the quarter came from the individual business. Fairly evenly spread across the country. Very strong growth in the 20 plus markets that we now have opened in individual.

And I would remind you that, we compete in markets where we can medically under right each individual and price accordingly. We do have a few markets where we had guaranteed issue that is required is a result of plan pay, player pay.

But our individual growth is been strong across all markets. And I wouldn’t particularly spike out anyone market is being more competitive than any other.

Matthew Borsch - Goldman Sachs

Okay. Thank you. And if I could turn to, you already talked on the national account activity. I think you said last quarter that the proposal activity was up but that the deaverage account size is down, do you have any revised view of that now, do you still sort of see the higher activity or pre activity being offset by smaller case size or is that really no longer the case?

Mark Bertolini

I would say nothing is really changed. It’s still too early to tell and part of the case size going down as there we have invested in penetrating the 3000 to 10000 market this year as well from the competitive standpoint that has been our market that we have been effective in past years. And so I think that’s one of the reasons why our overall case size is down on the proposals.

Matthew Borsch - Goldman Sachs

And any early sense on where you think employers might go with cost sharing, increases in cost sharing relative to maybe what they did coming in this year and their appetite for consumer-directed products?

Ron Williams

We have seen the increased interest in consumer-directed products for sure which obviously leads to higher cost sharing on the part of employees. What we have not seen on renewing business this year so far and wouldn’t expect to see any different next year any increasing cost sharing or cost shifting to employees than we have seen in prior year some benefit items. However, we have seen a new groups coming towards pretend by down from the position they were before with their priority area.

Matthew Borsch - Goldman Sachs

Fantastic. Thank you.

Ron Williams

Yeah. Matt probably the only point I will make additionally is that our whole approach is really in the context of having a strategic multi-year relationship with the client. So that the plant design in any given year is the reflection of the strategy and the employee benefit strategy that the client is pursuing. And so as Mark described those clients who have with us are moving through that strategy pretty effectively and somewhere those who are coming new tend to make bigger changes consistent with the broad set of products we have that they may not have an opportunity we exposed to.

Matthew Borsch - Goldman Sachs

Great. Thank you.

Operator

We’ll take our next question from Scott Fidel with Deutsche Bank.

Scott Fidel - Deutsche Bank

Thanks. First question, I’m wondering if you could give us some early expectations on medical cost trend assumption for 2008. And also just thinking about are there any new technologies or treatment innovations that are coming into the market in 2008 that we should be thinking about?

Ron Williams

Yeah. I would say in terms of 2008, we haven’t yet provided medical cost trend guidance. I would say we don’t see any major issues on the horizon as you know we develop our medical cost trend forecast from a bottom of point of view in terms of looking at unit cost in all the markets. We have some visibility that we are comfortable with that will be sharing that in the future. So I would say kind of stay tune for that. In terms of technology the medical cost approach that we take looks at both the addition of new technology and we have most importantly often changes in site of procedure is one of the things that we do take into account. I would say there is nothing a dramatically new we are also obviously watching the pharmacy area and some of the items that will be go in generic at least so source generic initially and we’ll have some a great (ph) impact.

Scott Fidel - Deutsche Bank

Okay and Ron I am wondering if you could talk a little bit about how you are thinking about positioning the Medicare Advantage business just in the long-term and obviously there is lot of growth in the market right now, but we are seeing a change in political landscape here down in Washington? And how do you think about that business longer-term especially if the Darmstadt (ph) takes back White House in 2008?

Ron Williams

I think one of the messages that we try to be very consistent are on strategically is that we want to build a broadly diversified business in which we really focus on define customer segments that we build products and solutions that give us sting power in the context of those solutions and so we view Medicare Advantage as a good business we thought positioned ourselves effectively in it by building very solid networks in place. We’re very active in the political debate and in the political arena, trying to educate congress on the benefit to the Medicare beneficiary of the program and the high degree of satisfaction in particularly low income seniors are driving by participating in these programs.

So, I think that it’s something that we are watching I think that it is clearly hardly discussed and the recent legislation that came out of the center and is the defend committee and has been graphed out some of the house committees as reflected by the different points of view. So you can expect that we will be at the table engaged and that we see it as one of many customer market segments that we will serve quite effectively.

Scott Fidel - Deutsche Bank

Okay. Thank you.

Operator

We’ll take our next question from Charles Boorady with Citigroup.

Charles Boorady - Citigroup

And congratulation to Mark, by the way fantastic news and well deserved. Ron, are the big three auto manufactures for the HRPA relationship and whether they are or not, I’m curious to your opinion on? Do you think the upside of those negotiations might result in union retirees adopting Medicare Advantages of more cost efficient way for them to receive heath benefits even if it’s subsidized by Medicare?

Ron Williams

Yeah, in terms of the HRPA membership I don’t think it’s probably appropriate for us to comment on their membership I think that they reflect to 250 largest corporations in America and I think they are probably reflective of many different sectors. I think that in terms of the, same question I’m going to ask Mark too to comment on.

Mark Bertolini

Charles, thanks. Thank you. I would also add that on the early retirees and some of the buyouts that we’ve seen going out of the auto companies. We have launched specific programs aimed at those are early retirees from our individual business and have had some success in growing our individual businesses result of having people coming out of early retirement from the autos.

Charles Boorady - Citigroup

That is a blue color or white color?

Mark Bertolini

White.

Charles Boorady - Citigroup

Okay. And separate question now on the commercial business. I am curious what you see is the sustainable organic risk enrollment growth in the commercial business and we got really good data points over the last year on the relationship that seems to exist between the higher enrollment growth last year on lower gross margins and then this year still good enrollment growth on higher profit -- higher gross margins meeting yield lower than loss ratio and I am just trying to, over the next few years estimate what the organic risk enrollment growth would be if I assumed stable margins on the net loss ratio line.

Ron Williams

Charles, I apologize but could you repeat that question I want to be certain what answering the right question here.

Charles Boorady - Citigroup

Yeah, what is sustainable organic risk in Romic (ph) growth, and will be long-term if you seems stable med loss ratios because we saw right swings in your growth rate and right swings in the med loss ratio in the last year, it seem like when the loss ratio was higher yet faster Romic growth, med loss ratio was lower get slower Romic growth as so?

Ron Williams

Yeah, I think you drive in core relations -- its not quite (inaudible) but its moving in that direction in terms of things that really are and terribly causing effect here. I think though I would think about it is that we look at each customer market segment as a define business.

We look at the customers in that customer market segment both from a type of a customer as well as geography. And the types of growth that you have seen, is a reflection of understanding the needs of those defined customers.

Building products, the services and capabilities that offer them good value and then geographically expanding those offerings in way it give us an ability to compete and grow in environments that we believe offer us opportunities the profitable enrollment growth.

So, I think that its, I would encourage just to think about our booker business as one booker business but really a collection of distinct businesses with the collection of the distinct value propositions price points all build from the customer back and so, I think that’s how I would try to answer.

Charles Boorady - Citigroup

That’s where they seems to be working really well and what you saw what percent growth you think is sustainable if I have seen the whole book, is roughly consistent in terms of its profitability and profit margins? 3% or 5% that kind of range?

Ron Williams

I think if you look at our kind of goal of 15% EPS growth we’re essentially assuming this kind of 3 to 5 points on the membership side would be the answer.

Charles Boorady - Citigroup

Okay. Great. Thank you.

Operator

We’ll take our next question from Josh Raskin with Lehman Brothers.

Josh Raskin - Lehman Brothers

Hi, thanks. One quick question on the membership by just looking across the geographies and like their, the funding mechanisms look like the west membership, the risk membership and the west was strongest up about 34,000. What segment and what states with that?

Ron Williams

I’ll ask Mark to comment.

Mark Bertolini

Hi, Josh, we actually made some investments in opening new markets in the last, we including California and opening at Central L.A. in parts North from the Southern California marketplace. We saw that growth across the all of our risk segments. So wasn’t necessarily in any one place. And so California is indeed the West coast is indeed having good year.

From our segments, from a geographic segment across the country we had very even growth across the all of our geographic segments except in the North East where we had some adjustment to one of our small group products that we mentioned in the second quarter call last year where we give discontinued product on January 1st. So we saw slight decline in our membership in the North East otherwise we had fairly even the growth across all of our regions.

Josh Raskin - Lehman Brothers

Okay and other quick question for the Joe on the cash flow. Its look like the income tax payments negatively impacted the cash flow, was that the extra (inaudible) payments and is there a way to quantify how much cash taxes you paid in the quarter?

Ron Williams

Yeah. I think the way to look at it, is the cash flow variance due to federal income taxes was about $400 million and if you pro forma for CMS reimbursement and Federal tax payments we are on target to hit our 120% to 130% of operating cash flow as a ratio of GAAP net income for the year.

Josh Raskin - Lehman Brothers

Okay. And just a quick last question just a follow-up, I think you said in your comments Joe, that there was no material prior for your reserve development. I believe last year when you guys where still disclosing that the commercial number was 11 million.

So, should we assume that it was a similar amount this quarter or did you mean to say there was no amount this quarter?

Joseph Zubretsky

Well, on $2.1 billion a reserves we never get to pick right, but when its material, we’ll certainly draw attention to it, if it’s attract an investors view of our results, but we just prefer at this point to say it was immaterial for the quarter.

Josh Raskin - Lehman Brothers

I just look at it is, you know, it’s about 25 basis point impact on the MLR. So, just trying to figure out in terms of year-over-year change in MLR are we flat would be 80.5 adjusted number you gave or are we slightly up or slightly down?

Joseph Zubretsky

Actually, that’s the more relevant that you’re asking. If you remember last year in the second quarter there was an overshoot on medical cost due to misinterpretation of some large claim activity in a couple of cases. And that 81.1% reported commercial medical benefit ratio settled at 80.5 and I would say the best comparison you can make is the 80.5 Q2, '06, Q2 '07 is a very good comparison.

Josh Raskin - Lehman Brothers

Okay. Thanks very much.

Operator

We’ll take our next question from Al Copersino (ph) with META.

Al Copersino - META

Thanks very much and congratulations. I’d a question about the SG&A, you've made a pretty clear that there is a series of improvements and efficiencies that are driving the vast majority of the SG&A improvement along with, I guess leveraging top-ling growth.

My question on the SG&A relates to business mix. Medicare is a very small piece of your company but it appears to be growing pretty quickly. Medicaid is an opportunity and as you've talked about you are growing in lots of different areas across the country, I am wondering if business mix or geographic mix will also creates a tailwind on the SG&A ratio? And if can comment on that?

Ron Williams

It should overtime, but I would, right now Medicare is growing at a substantial rate. But as you know offers small base. So, right now it’s not affecting that ratio to a great extent. As product mix gets to be a bigger part of the SG&A comparison story, we will certainly articulate that for you. But right now it’s really immaterial.

Al Copersino - META

Okay. Thanks lot.

Ron Williams

You’re welcome.

Operator

We’ll take our next question from Peter Costa, FTN Midwest Securities.

Peter Costa - FTN Midwest Securities

Just a question on the 64,000 members of growth that you had saw, others reported have talked about some in-group declines. Did you experience similar in-group decline? And then just find enough new business to replace that particularly on the self insured customer base?

Ron Williams

I’ll ask Mark to give you some background.

Mark Bertolini

Peter, we actually in the national accounts segment, where I think others reported declines actually were even or fairly flat for the quarter-over-quarter from the first quarter. We had a few thousand decline in the corporate sector and a few thousand increase in the government sector that also one another.

Peter Costa - FTN Midwest Securities

Were those in group declines or were they lost accounts or what exactly cause that?

Ron Williams

That is the in group change.

Peter Costa - FTN Midwest Securities

Thank you.

Operator

We will take our next question from Christine Arnold, Morgan Stanley.

Christine Arnold - Morgan Stanley

Good morning. Couple of questions; do you expect robust up taken second half growth in membership versus what you have this quarter I am calculating about 240,000 incremental member’s second half. How many of those that you have already won?

Ron Williams

Christine, good morning. I would say that we feel very good about the remaining membership growth and given that September is a very strong month in the overall business cycle when we have very good visibility. So I would say that we have good visibility on a significant portion.

Christine Arnold - Morgan Stanley

Okay and is it safe to say that you expect membership entering ’08 to be more robust than it was entering ’07 given the higher SG&A spent fourth quarter ’07 versus fourth quarter ’06 or would that be a foolish assumption?

Ron Williams

No. The short answer would be, yes we do as we know more will share more but I would say that we feel very positive. The one exception I would remind you obvious that in instances as we attract private-fee-for-service business in cases where we have the existing case. You would see revenue growth but not necessarily membership growth.

Christine Arnold - Morgan Stanley

I am confused. Can you help me to that?

Ron Williams

Yeah. Let’s say we have a large client who has a self-insured Medicare supplement plan who is part of the human resource policy association and convert to Medicare advantage. That’s not new membership but it is net revenue.

Christine Arnold - Morgan Stanley

Fund modeling, okay and then on the debt comments that you guys made. Should we assume traditional debt? Because I think you have been talking about kind of hybrid securities. Can you talk a little bit about that? That’s my final question.

Ron Williams

Yes, Christine. As a first step in moving toward an optimal capital structure, we would fill up to 25% debt to total Cap with straight debt.

Christine Arnold - Morgan Stanley

Okay.

Ron Williams

And as part of that plan that we will be ensuring with our Board of Directors in September, we will be evaluating the introduction of hybrid securities into the capital structure. But that would be a second step.

Christine Arnold - Morgan Stanley

Can we assume something like a big share repurchase like a lump share repurchases or would that be too aggressive?

Ron Williams

That is one of the options being evaluated. But right now our goal in our plan is open market purchases.

Christine Arnold - Morgan Stanley

Okay. Thanks.

Operator

We will take our next question from John Rex with Bear Stearns.

John Rex - Bear Stearns

Thanks. I just wonder if you could give us some, few highlights on what you are seeing in terms of drivers of the -- I think you’ve just got a slightly negative bad debt trends and kind of just your view, you lookout as sustainability stable or continue to slightly negative trends on the impatient side and again focusing on just the utilization bad debts.

Ron Williams

Yeah. I think John the what we’ve seen is that if you contrast the second quarter of this year in relation to second quarter of last year that because of the SAP loss and other issues we described in prior year. The utilization is relatively down.

But I think we would characterize it as modest in this game of things and would say that the medical cost trends that we have given are good estimates. We would say that if you were up -- and I really have many answers, but just to provide some color on the trend components that the trend components in patient I think in the last discussion we’ve talked about high single digits.

We probably characterized that today is a kind of mid-single to high-single digits. We have talked about the out patient trend is continuing in the same range as before I mean high-single to low double and our physicians in the mid-single and pharmacy in the mid-single.

John Rex - Bear Stearns

But if I am correct, you did see, you got slightly negative bad debt trends, is that correct?

Ron Williams

Yes. That’s correct.

John Rex - Bear Stearns

Okay. And you would necessarily, I guess look for. I am just kind of curious because its seem like -- when we think about kind of sector wide and you could speak just (inaudible) your experience, but are they particular factors you think that are driving that kind of experience and I guess I think about a bit in sustainability, should we expect that should kind of continued, is there any reason to expect a bad debt shouldn’t be at this level?

Ron Williams

Yes, I’ll ask Mark to give you more color.

John Rex - Bear Stearns

Thanks.

Mark Bertolini

Yes, John. A number of factors first in formals to we see shorter length sustained and sure hasn’t impact on bad debt so, you know that is continuing phenomenon and that has been underweighting and part of the underlying production in bad debts for the past five years or so.

Secondly, we see slight of service changes some of which we drive on our own through reimbursement methodology and through our right now health connections and through educating our members.

And so as the services move out of the hospital they moving the all patient environment we are seeing fewer bad debts so, we continued to look for ways to reduce the bad debt numbers year-over-year not always necessarily well they be cheaper in the near term, but we believe in a long-term, more effective.

John Rex - Bear Stearns

Okay. And just one question on Schaller Anderson is there an opportunity or did they even make sense to try to look at converting some of that business to risk base? Is that something that you would consider or is that even interesting to you?

Ron Williams

Well, I think we always start with find and meet the need of our customers. And what we want to do is serve the solutions that are customers want to buy. And I think given our capability on managing risk, we believe there maybe customers who would view that as a very good solution.

And I think the whole purpose of the acquisition is to acquire the skills and competencies it helps us to grow the Medicaid segment and then we’ll be able to really leverage at across our entire geographical infrastructure where we have state to divest us could we participate in the Medicaid program.

And we really didn’t feel we had the capabilities in infrastructure to scale up a faster then we have to meet their needs and so, we generally very excited about this, it’s a great team, I’ve talk many of their clients, their clients think they are terrific and we are just very excited about the prospect of adding this segment and I will ask Mark to add little more.

Mark Bertolini

Charles, I would also note that we also see great opportunity in the fee-for-service side of Medicare particularly in the ABD and long-term care populations. And that has a lot of opportunity relative to controlling costs and getting a better result in quality of care for the members in lower costs.

John Rex - Bear Stearns

Great, thank you.

Operator

We’ll take our final question from Doug Simpson with Merrill Lynch.

Doug Simpson - Merrill Lynch

Good morning. Lot of my questions had been answered, but Joe I was wondering if you could just maybe give us some color on the conversations you are having. I know you are focused on this sort of debt to cap levels that would be deemed appropriate by some of the rating agencies and another constituents. And just sort of how successful do you feel you are in that front and sort of what is your strategy for talking about that issue?

Your interest coverage down I guess 16 to 18 times and 20% debt to cap, there is certainly room to move your identified 25%. I’m just wondering could you maybe push that to closer to 30 over time?

Joseph Zubretsky

Yeah and I think you hit the right issue. I think we also I guess on the traditional what I call the insurance company measure, total debt to total cap measure on a book basis and we forget the cash flow dynamics in velocity of the business.

Our coverage ratio of our fixed charges is over 18 times. Our debt levels are measured as a percentage of EBITDA are only at point eight. And AAA companies are at 1.5 to 2 times. So there is a lot of room in balance for additional debt as we say we are certainly comfortable with 25% and we absolutely would be comfortable with 30% for the right opportunity whether that opportunity is to repurchase shares or to engage in M&A activity is yet to be determined.

But I think you are hitting the right issues. There are measures that need to be evaluated that take into consideration the cash flow dynamics of the business and that’s what we plan to articulate.

Ron Williams

This concludes the second quarter 2007 earnings call and webcast. A transcript of the prepared portion of this call will be posted shortly on the Investor Information section of the Aetna website at aetna.com. If you have any questions about matters discussed this morning please feel free to call David Entrekin or me in the Investor Relations office. Thank you again for joining us this morning.

Operator

That does conclude today’s conference call you may now disconnect.

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