UnitedHealth Group Q3 2007 Earnings Call Transcript

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 |  About: UnitedHealth Group Inc. (UNH)
by: SA Transcripts

Operator

Good morning. My name is Dennis and I will be yourconference facilitator today. At this time, I would like to welcome everyone tothe UnitedHealth Group Third Quarter 2007 Earnings Conference Call. All lineshave been placed on mute to prevent any background noise. After the speakers'remarks, there will be a question-and-answer period. (Operator Instructions)

As a reminder, this conference is being recorded. This calland its contents are the property of UnitedHealth Group. Any use, copying ordistribution without written permission from UnitedHealth Group is strictlyprohibited.

Here is some important introductory information. This callwill reference non-GAAP amounts. Reconciliation of non-GAAP to GAAP amounts iscontained on the 'Investor Information' section of the company's website atwww.unitedhealthgroup.com.

This call contains forward-looking statements under U.S.Federal Securities Laws. Such statements are subject to risks and uncertaintiesthat could cause actual results to differ materially from historical experienceand present expectations.

A description of some of the risks and uncertainties can befound in reports filed with the Securities and Exchange Commission from time totime, including the cautionary statements included in our annual reports onForm 10-K and quarterly reports on Form 10-Q, as well as our current report onForm 8-K, filed in connection with the company's October 18, 2007 earningsrelease.

Information presented on this call is contained in theearnings release and Form 8-K, dated October 18, 2007, which may be accessedfrom the 'Investor Information' page of the company's website atwww.unitedhealthgroup.com.

I would now like to turn the conference over to the Presidentand Chief Executive Officer of UnitedHealth Group, Stephen Hemsley.

Stephen Hemsley

Good morning and welcome to our 2007 third quarter earningscall. This morning we will review our third quarter performance, and coverother topics of interest including our initial outlook for 2008.

As always, we have a number of our executives available foryour questions on this call. Afterwards, John Penshorn, Brett Manderfeld, MikeMikan and others will also be available to respond any additional questions.

The themes for this quarter were continued fundamentalsstrengthening of operations and earnings growth, which we will illustrate withsome highlights from this morning's press release.

In the third quarter, we earned $0.95 per share, an increaseof 19% over the third quarter of 2006. Fourth quarter results are currentlyprojected to be in the range of $0.91 to $0.92 per share.

Seasonal increases in medical costs in the commercial riskbusiness and in Medicare Advantage marketing expenses are projected to be partiallyoffset in the fourth quarter by seasonally strong Medicare Part D and IngenixHealth Technology results.

This would bring full year 2007 earnings to an adjusted$3.49 to $3.50 per share. This performance would be 18% above our 2006performance and substantially above the $3.40 per share target we establishedat the start of 2007.

Our expectation for 2008 is a return to balanced growth,stronger operational execution to predictable earnings performance.Specifically, we anticipate earnings in the range of $3.95 to $4.00 per share.This assumes the expected closing of the Sierra acquisition before the end of2007, and approximately $7 billion in further share repurchase between now andthe end of 2008.

This preview of 2008 assumes revenues of approximately $83billion, including Sierra and an operating margin in the 10% to 11% range.

Compared to 2007, operating earnings would be up around 7%to 9%, which as you know excludes incremental financing charges, and full-yearweighted average shares would decrease by as much as 7%. Earnings per sharewould be up roughly 15% when compared to $3.49 to $3.50 projected for 2007.

Cash flows from operations would approach $7 billion in2008. I am sure there is an appetite for greater visibility into 2008 and wewill discuss 2008 in greater detail at our December 4th Investor Day.

Over the longer-term horizon, say 3 to 5 years, we seeaverage annual EPS growth in the 13% to 16% range, that range encompassesorganic growth, productivity advances, ongoing capital structure management inmoderate levels of M&A activity.

Above all, it considers our current projected operatingearnings base, which is approaching $9 billion. The pressures we see in thecommercial benefits marketplace, continuation of current levels of medicalinflation, as well as the opportunities we are pursuing as we continue todiversify our businesses.

Obviously, the actual growth rate will vary year-to-year,but our sense is that this range is right for now.

Focusing now on the third quarter. It featured strength inearnings, margins and cash flows, and a sequential improvement in thecommercial risk medical care ratio. We also saw a growth and advancingperformance in a range of business units, including Evercare, Ingenix andAmeriChoice.

Our diversified market facing business model continued toserve us well as the year progresses.

Operating earnings increased 16% year-over-year to more than$2.1 billion. And our operating margin expanded 110 basis points to 11.5%

The third quarter consolidated operating cost ratio was 14%.This ratio increased 50 basis points year-over-year, reflecting the growingimpact of business mix, as businesses, such as Ingenix, meaningfully increasedtheir contribution to our total operating cost trends, and investments we havemade to improve performance in service and to senior business marketing, whichwe will describe shortly.

And I would point out that operating costs increased only$11 million sequentially, so the increase is minimal from an aggregate dollar impact.

Normalized cash flow from operations for the quarter were$2.1 billion, a strong ratio of 1.6 times net earnings and we are on track forfull year cash flows of approximately $6.2 billion.

We repurchased $2 billion in stock in the third quarter, bringingthe year-to-date total to nearly $4.5 billion. We have now bought just under 1billion shares on a cumulative basis over the last 10 years at an average costof about $21 per share.

Our financial position remains sound, with the debt-to-totalcapital utilization ratio of approximately 28%, and we have $1.5 billion inavailable cash.

Return on equity exceeded 24% in the quarter, reflectingpositive margins and the increasingly efficient capital base.

These financial gains were matched with investments andimprovements in execution of fundamentals within our core operations. Werecognize that our customers and care providers want continuing focus from usin several distinct areas.

They are looking for us to continue to advance health systemaccess and affordability. They expect our continued leadership in productinnovation and capabilities, that center around the quality and effectivenessof care and that increasing consumer engagement in health care.

And they want us to continue to elevate our performancearound service, cost controls and execution. We made important operating gainsin each of these areas in the quarter.

In the first instance, we continue to expand our proprietarycare network, already the largest and broadest single network in the country.

In the third quarter, we added 20 new hospitals and 19,500net new physicians and health care practitioners. This includes retaining oradding some of the highest profile hospital systems in their markets. Recentexamples include multi-year arrangements with BJC in St. Louis, Swedish Hospital in Seattleand St. Louis in Cincinnati.

Access to partners like these strengthens our offerings tocustomers in each of those local markets. Our networks meet care accessstandards for 97% of the U.S.population.

And today we maintain direct contractual partnerships, withroughly 85% of the health care delivery resources in this country. Networkdevelopment is an area where we have made clear and significant advances.

We continue to lead on products and capabilities thatincrease consumer engagement, particularly around quality care.

Our premium designation programs in clinical integrationdesigns within our broad network represent distinct capabilities that transcendany specific type of product. They increasingly help people get to the bestplaces and practitioners for their care.

Some 15 million of our consumers now have access tophysicians, specialists, premium designation programs in their market. Andconsumers in 85% of our markets have access to differentiated hospital qualityand efficiency data online.

And our consumer-directed health benefit products achieved24% organic growth over the last year. That is 440,000 new consumers and weserve a market leading total of over 2.3 million consumers, participating inthese products today.

In the third area of interest, we have focused all year onimproved accuracy and responsiveness in fundamental service processes.

I initially mentioned this on our first quarter conferencecall, six months later we can point to early advances that meaningfully improvethe service responsiveness of our organization.

Claim service is returning to competitive performance levelsat PacifiCare and we expect further advances in 2008.

In the claims area, dollar and financial accuracy are at anall-time high, consistently above 99% over the course of this year. And callquality and accuracy are sharply stronger in both consumer and physicianchannels as compared to 2006.

We have significantly expanded our rapid resolution servicemodel, which uses empowered executives to provide more responsive service toresolve transactions that are more complex or are in conflict. Theseimprovements are bearing results in meaningful ways for people.

Consumer survey show post-call satisfaction running above90%. And brokers and employers are seeing better performance, as reflected inthe strongly improved results in the service performance guarantees we provideto these customers.

We expect these gains will accelerate into 2008, supportedby further reaching actions in continuing focus.

Let me touch briefly on these areas. Over the past eightmonths, we positioned the commercial service and operation functions, as wellas our technology organization under the [Dirt Mickman] and David Wichmann,which pulls together key assets serving all of our commercial markets under twoof our best operators.

We are also better aligning our services and responseoperations to more directly linked to the service to serve local marketsettings. We use our technology and service applications to provide moreimmediate response at local market levels, empowering our people to respondmore quickly to market specific needs.

Finally, we are realigning incentive compensation for ourexecutives, to our front-line employees to more directly tie to our performanceon fundamental consumer and care provider services and satisfaction.

We will be more accountable to consumers and care providers,listening more closely than ever and providing the exceptional service to theseconsumers and care professionals expect and deserve from us.

Let me now turn to the businesses, beginning with the HealthCare Services segment. Third quarter business developments for the public andsenior market group included gaining some 95,000 seniors, while Medicaidenrollment remained stable.

The senior growth breaks out as follows: 20,000 new seniorsin Medicare advantage, 35,000 in active Medicare supplement and 40,000 instand-alone Part D plans.

Margins improved for Ovations and AmeriChoiceyear-over-year. In fact, it was the strongest AmeriChoice earnings quarter,with the lowest medical care ratio in a number of quarters.

We expect this performance level to continue into 2008,supported by stable medical care ratios and quite steady growth. We entered the2008 Medicare selling season much better position for meaningful growth in lastyear.

There are four reasons for this optimism, more competitiveproducts and expanding geographic footprints, great branding and improvedexecution.

Specifically, we go to market for 2008 with generallystabled or enhanced benefits, including strongly competitive private-fee-for-serviceplans.

We have expanded our Medicare Advantage footprints for 2008.For example, we see expansion markets for network-based Medicare Advantageofferings include Boston, WashingtonD.C., Chicago, Atlanta and Kansas City.

Evercare chronic illness Special Needs Plans will expandfrom seven states in 2000 to 34 in 2008. These are all states where we alreadyoffer Medicare Advantage, so we efficiently leverage existing local operationsand where our networks are broad and strong.

From a branding perspective, we now offer the only MedicareAdvantage product that carries the AARP name. We are obviously very excitedabout both the immediate and long-term potential for this exclusive alliancewith AARP to 2014. And we are promoting this with an intensive multi-mediacampaign.

Finally, execution around marketing, sales and enrollmenthas been meaningfully strengthened, with key investments in leadershiptechnology and infrastructure, and by the much more complete integration of Ovationsin SecureHorizons.

For example, we have a stronger and better organized networkof contracted and certified brokers. They are more aligned, better trained andbetter paid and they clearly understand the need to deliver accountable resultsto preserve their ability to sell AARP-branded products. We also have muchgreater direct access to an oversight of their day-to-day efforts.

We have launched our own internal agency with brokers fullydedicated to distributing our products, including individual insurance andchronic Special Needs Plan and traditional Medicare Advantage offerings.

All products communications, marketing and enrollmentmaterials have been fully adapted for local market uses. They were into thelocal markets well before the enrollment season, which was not the case lastyear and which undoubtedly affected our results.

We have tightened and automated the enrollment submissionprocess to drive simplicity, increase speed and eliminate potential [sourcesthere]. And we have established a command center to monitor, analyze and adjusttactical approaches daily as required.

We are off to a strong start and we want to drive thiscampaign for the next two and half months.

On the public market side, we are well positioned forpotential SCHIP expansion and are working to grow pipeline, a state programexpansions and procurement opportunities including Tennessee,Iowa, Missouriand others.

Turning to our individual and employer markets, thirdquarter membership in this group declined by 115,000 people. Fee-based growthat UnitedHealthcare of 80,000 consumers was more than offset byemployment-related attrition at Uniprise and a decline in UnitedHealth riskmembership, including the 70,000 decrease from PacifiCare.

We expect that year end 2007 membership would be slightlydown from the total for this group at September 30. Much of our commercialmembership decline stems from a conscious decision to put profitability aheadof top line growth. Achieving both was difficult in 2006 and 2007, but in 2008,we are committed to doing so.

In 2008, we expect our commercial risk membership to declinein January then strengthen modestly quarter-by-quarter in the second half of2008. We are refocusing on the local market dynamics and the needs of thesecommercial benefit markets, which continue to become more consumer oriented.

We have introduced a number of new innovative products tosee these changes, directly engaging consumers and making effective healthchoices and decisions.

Specific new offerings address both consumerism andaffordability, including the Golden Rule and Definity consumer-directed productlines. United with Me, which focuses on employee activation and wellness forthe very large employers.

The new Vital Measures product line to engage, encourage andreward healthy behavior. And the recently launched Edge product line, whichinforms and motivates people to use the best doctors and hospitals.

This innovative package brings the market abroad, nationalpremium designated network at significantly reduce price points by usingbenefit designs to encourage consumer choice that drives cost-effective qualityand care.

Edge will be active in 20 markets by January, with theremainder to follow over the course of 2008.

At Uniprise, we had customers who sponsor more than 2.5million members out of market for January 2008.

In all then we should net out to an estimated Januarydecrease of between 80,000 and 100,000 people.

UnitedHealthcare fee-based enrollment is also expected todecline slightly in January and then grow throughout the year more thanoffsetting any in-year attrition at Uniprise.

Participation in risk-based offerings for UnitedHealthcareis expected to be down in January, although it is too early to quantify at whatlevel. We are committed to sequential improvement in risk-based result for therest of the year.

We see that improvement coming from four key areas: newproducts, which I just described; an expanding network; improved service; andbetter local market dynamics. We expect 2008 growth in diverse market segmentssuch as student, individual, and ethnic groups and through geographic marketexpansion such as Sierra and more effective local market engagement across theBoard.

We expect our traditional markets to strengthenprogressively quarter-by-quarter in the second half of 2008, as new productsgain traction with brokers and employers. These products will reach marketsegments that are more price sensitive than those of our traditional productlines.

The third quarter medical care ratio for UnitedHealthcare of81.6% improved 40 basis points sequentially. UnitedHealthcare also saw afavorable increase in per member per month premium yield this quarter.

We continue to estimate the full year 2008 UnitedHealthcaremedical care ratio in the range of 81.5% to 82%, implying a fourth quarterratio of around 83%. This is an appropriate expectation given the higherutilization of services expected in the fourth quarter.

For full year 2008, UnitedHealthcare is pricing to achieve astable medical care ratio, subject to normal seasonal variation.

Our medical cost trend continues to run in the area of 7.5%for 2007, with no notable deviations in individual cost categories.

We are projecting only a slight uptick in cost trends in2008, principally due to changes in public policy and evidence-based careguidelines and we have incorporated that into our pricing.

There is much more to be done in this group. We are deeplycommitted to improving our performance and commercial benefit growth in overallservice levels, productivity and innovation efforts. We expect our efforts inthis domain to be evident in 2008.

Let me now turn to the enterprise services market. Again, Ingenix,Exante and newly re-branded OptumHealth all reported solid growth andprofitability this quarter. In fact, we expect these three businesses tocontribute more profit in 2007 than the entirety of UnitedHealth Group had in theyear 2000.

OptumHealth's third quarter results were stable with thesecond quarter and had a solid margin of 19.1%. More than half of OptumHealthcustomers are external, and we believe the best growth opportunities lie inthese external markets outside our walls. We are making it easier to dobusiness with us by unifying a portfolio of companies into a single integratedand external facing entity.

One that pursues public sector business and externalemployers and payers business, even more aggressively and brings to thosemarkets a wealth of integrated capabilities cost, the specialty network andhealth financing spectrum.

Exante continues its rapid expansion, while traditionalfinancial institutions have been attempting to move into this market, we don'tbelieve any traditional bank can integrate its financial services with the healthcare system the way Exante can.

For Ingenix, the relative momentumcontinues this quarter. Year-over-year revenues were up 40%, earnings fromoperations up 35% and revenue backlog up 46%. And each of its future businesspipeline measures is up triple-digit percentages year-over-year.

The demand for Ingenix Services isgrowing rapidly as health plans, employers, state government, delivery systemparticipants, and pharmaceutical and device companies are increasing theirdemand for data-driven products and services.

Lastly, we are driving external pharmacybenefit sales across the company. Uniprise will be providing pharmacy benefitmanagement services on an insured basis to 1 million people in the entire planin New Yorkon January 1.

UnitedHealthcare will serve nearly300,000 Georgia State Employees. In prescription solutions, recently securedfulfillment services for private health benefit systems were 1.2 million members.

Let us also update you on our rebuildingefforts in relationships and in becoming better overall stewards of thisenterprise. I will offer one example in the work we are doing with a largecross-section of hospitals and physician groups to mutually streamline andimprove end-to-end transactions processes and similarly, with practicemanagement systems vendors through Ingenix [sort of] improved our directelectronic connectivity and the accuracy of the data submission.

We are working with the American Collegeof Physicians, the American Academy of Family Physicians and the American Academy of Pediatrics under Reed Tuckson'sleadership, highlighting the medical home reimbursement model with primary carephysicians in select markets.

In two separate instances this quarter,regulators asked UnitedHealth to step in and assist with troubled healthbenefit systems. Separately, we are designing a process for meeting with someof our long-standing shareholders to engage in direct conversation about theperformance elements of our executive compensation system.

And we continue to take a very structured approach toexecutive development, with our most talented leaders moving regularly to gainexperience in new roles. We've made a number of senior leadership changes inthe past 90 days.

[Dr. Bill Gillespie] has moved to become the Chief MedicalOfficer of Ovations, a new role for this segment. We are excited to have DawnOwens as Chief Executive Officer of OptumHealth, and for John Prince to becomethe Chief Operating Officer of OptumHealth.

We have Chad Wilkins join us from U.S. Bank to lead Exante.We are fortunate to have had Jud Sommer from Goldman Sachs to service our newHead of Government Relations. And we are also delighted to have Mike Matteo tobecome the new Chief Executive Officer of Uniprise. Mike combines years ofexperience at Uniprise in both client sales and development, with great energyinsight and intense customer focus.

Tracy Bahl is pursuing personal interest he has outside ofUnitedHealth Group and we thank Tracyfor his many years of outstanding service to Uniprise and wish him well. We arealso achieving meaningful improvements through greater enterprise leveloversight in coordination in order to drive our competencies really to theirfull potential.

In that vein, various executives have taken on additionalenterprise-wide oversight responsibilities; including Mike Mikan in network,care facilitation and health care economics; Dr. Reed Tuckson in clinicalpolicies, practices and progress; Dave Whitman in technology, operations andcompany-wide integration; Tom Strickland in administrative services, processesand controls; Andy Slavitt in all clinical information assets, resources andapplications; and Bill Whitely in commercial marketing, distribution channelsand revenue pipeline management.

At the business unit and market segment levels, anaggressive new generation of leaders is emerging. Under the direction of TonyWelters, Bill Munsell and Dave Wichmann, the season team of Ken Burdick, MikeMatteo, Rich Collins, Simon Stevens, Ken Fasola, Sheila McMillan, Rick Jelinek,Dawn Owens, Jackie Kosecoff, Andy Slavitt, Lee Valente and many other is especiallystrong indeed, which has been a hallmark of our company. You will see thatfirst hand at the investor conference.

And we will continue to recruit broad-based talent andexperience from outside our company and industries to enrich and diversifyexecutive resources and stimulate new thinking. We will close with a briefsummary.

This quarter, we have done what we had told you we would do.We refocused to improve fundamental execution and we maintain that sharp focus.We continue to expand and enrich the network. We have addressed specific yearintegration issues and expect that performance will continue to strengthenquarter-by-quarter throughout 2008.

We reengineered our marketing and sales approach to theMedicare sales season and we expect significant performance improvements. Andwe strengthened our discipline in pricing to cost across the commercialbenefits market even at the cost of membership growth.

Through the first nine months of this year, we have exceededthe individual quarterly consensus estimates by a total of $0.14 as adjusted.This is directly the result of our diversified, adaptable and market-focusedbusinesses. We are positioned to deliver a solid fourth quarter and to grow andexpand our business in 2008.

The key financial elements for 2008, including acceleratingMedicare Advantage business, stronger service performance, new product launchesto re-ignite growth in commercial markets, our continued commitment to pricingdiscipline and our ongoing commitment to responsible capital management wherewe expect to make some further progress as we close out the year. That's a shortand basic list and we intend to execute on it.

With that I thank you very much and we can now move toquestions.

Question-and-AnswerSession

Operator

(Operator Instructions). We also remind you that forpurposes of getting to as many participants as possible, we ask those with thequestions to limit to one question per person. We will pause for just a momentto compile Q&A roster. Your first question will come from the line ofCharles Boorady with Citigroup.

Charles Boorady -Citigroup

Thanks. Good morning. My question on prior perioddevelopments, if you can bifurcate between commercial and Medicare for thisyear and last year, the developments in the quarter?

Stephen Hemsley

Mike, you want to respond to that.

Mike Mikan

Charles, I just do not, I mean we’ve got development acrossall of our medical costs or book-to-business, not just Ovations, the Medicarebook or UnitedHealthcare. So I just do not break it out into its individualscomponents. I will tell you that with respect to UnitedHealthcare, we did seemodest developments from the prior year, say around $10 million or so.

Charles Boorady -Citigroup

And Medicare Advantage, the additional selling cost that youare counting on in the fourth quarter or incrementally how much higher in the fourthquarter versus third quarter should we expect? Anyone offer a response forthat?

Mike Mikan

Yeah, I mean I wouldn’t put a dollar figure on it, but Iwould agree there are a number of one time SG&A costs, which we will beincurring in the second half of this year, which won't be repeated in 2008 andparticularly the meaningful brand marketing and other campaign launch costsassociated with our new AARP Medicare Advantage Plan.

Stephen Hemsley

It won't be as intense in 2008.

Mike Mikan

Yeah, there are a number of startup costs which were buildingon SG&A this year.

Charles Boorady - Citigroup

Got it. So these were expenses is it going hit you in thefourth quarter for which you will see the revenues in 2008 for?

Mike Mikan

That’s right, and we wanted to incur the time level ofSG&A startup costs into 2008.

Charles Boorady -Citigroup

Right. I think that’s an important point. Thank you.

Stephen Hemsley

Thank you.

Operator

Your next question will come from the line of Lee Coopermanwith Omega Advisors.

Lee Cooperman - Omega Advisors

Thank you very much. I appreciate it. If you go back to theold DuPont formula ROE times retention equals to sustainable growth. We clearlyare retaining much more earnings than we need to finance that business.

And historically and so far intelligently you’ve taken thoseexcess retained earnings and put it into stock repurchase. And you are really doingso in extreme, it’s very few companies of your size and your history that payno dividends.

So I guess the question I am really asking is how confidentare you that you are doing the right thing for shareholders that are notselling back their company and effectively enlarging our ownership as youbuyback stock.

And I guess this raises question as simple as that, becauseit is pretty extreme for a company of your size in profitability, not repaying ameaningful dividend?

Now I want to make it clear, I am not criticizing thebuyback by the way, I am just trying to examine that we sort this thing throughand at the end of the day, we are not going to be like CountryWide to spend $1 billionbuying back stock at twice the current price and now they are under capitalize.

Stephen Hemsley

Well I appreciate the question and our perspective has beenthat in terms of capital use our first priority is to invest it, kind of in aconsistent, a thoughtful way in a multi-year basis in the business itself, toreally focus on areas of business expansion through acquisitions that bringsome strategic value or bring us the capability that we get faster or moreeffectively through a purchase.

And then when we look at the remainder of the use of thatcapital and particularly relatively to our -- where we see the potential of ourbusiness and our valuation, we see the greater appreciation clearly dedicatedto the continued repurchase of shares and I agree completely that the cashgeneration capacities of these businesses is quite remarkable.

And continue to see that as the most appropriate course andthat has been our orientation and less on the orientation towards dividends. Ithink that's probably the most efficient approach to managing the capital.

Lee Cooperman - Omega Advisors

And I assume if you thought your stock was adequatelypriced, you would move away from stock repurchase?

Stephen Hemsley

If we felt that we got to a position where that disconnectwith the market as a potential that we see in the business and we saw then inthe long-term, we would have to consider that, yes.

Lee Cooperman - Omega Advisors

Okay. Thank you. Good luck.

Stephen Hemsley

Dividend consideration is always on the table. But when wego through that, the approach that we look at the marketplace, we see the firstthree as our priorities.

Lee Cooperman - Omega Advisors

Thank you. You are doing a very fine job running thecompany. I appreciate your efforts.

Stephen Hemsley

Thank you very much

Operator

Our next question will come from the line of Scott Fidelwith Deutsche Bank.

Scott Fidel -Deutsche Bank

Thanks. So, your new long-term EPS growth target of 13% to16%, can you talk about how you think longer term that breaks down betweenannual revenue growth, operating earnings growth and from capital deployment?

And then, maybe if could talk about the decision to changefrom the 15%, how much of that relates to the law of large numbers that you areseeing with the growth as compared to a difference in how you see theopportunities in the industry?

Stephen Hemsley

Yeah, I will let Mike and John talk about the elements ofit. I would like to keep that at a reasonably higher level in this discussion,because we intend to get into this in a significantly greater depth at theinvestor conference.

So we think that's the best venue for that. I would saythough that we think that there is very strong potential and opportunity interms of our business model and the businesses that we are in and in thebusinesses that we see in a path, as we continue to pursue diversification.

But it is impacted, I think in a significant way, by thefact that we're -- our operating earnings are approaching $9 billion. And ifyou take the long-term growth path on that given conditions we see in themarket place and the more moderate levels of medical cost inflation, which wethink will persist, that we thought the guidance was appropriate in that range.And if you want to get into just couple other broader strokes of that model.Mike, do you want to respond?

Mike Mikan

Scott, it's Mike. We will go through more in detail, thelong-term outlook and how we build it up. But just to give you some high levelmetrics, we expect long-term revenue to grow somewhere in the high single-digitrange.

Operating earnings, we target on average 8% to 12% say andthen the capital accretion or the use of capital whether through share repurchasesor the like for acquisitions we think we can get around 5% accretion on ayearly basis. So on average we think that would target around 13% to 16% annualEPS growth rate.

Scott Fidel -Deutsche Bank

Okay, thank you.

Operator

Your next question will come from the line of Peter Costawith FTN Midwest Securities.

Peter Costa - FTN Midwest Securities

Thanks. Can you talk about what's causing a decline of theFee based membership? Will just Aetna and [Signa] coming back, is it serviceissues or is it geography type of PacifiCare and Oxford, what sort of reallyissues there, can you get us through that a little bit?

Stephen Hemsley

Yeah I'll give you myreaction in all, I’ll add -- as such some others can predict and so forth theresponse but I would say that we need to strengthen our execution along alandscape of issues in terms of minimizing disruption in the market place. Iwould say a closer connection to local markets in local market dynamics as Isaid in our prepared comments.

And just basically more effective execution, energies andcustomer intimacy. So, I think it is a back to basics. And execution onfundamental, and a greater focus towards customers I think our elements thatwill bring that kind of market response back in the line. Ken?

Ken Burdick

Peter thanks for the question. Couple of things just tobuild on to Steve, first, we continue to reposition our PacifiCare business,and that did contribute significantly to the loss of this quarter.

We are very confident that, that work will stabilize afterJanuary of ’08. And we got some exciting things that we have introduced in themarket place. In the prepared remarks, you heard Steve talk about the edgeproduct. We just rolled that out in September, we’ve already several dozens salesas you heard in the script 15 markets by the end of this year and then 21 byJanuary.

In the fee business, we are really looking to build on themomentum that we have gained in the consumer activation products. And we talkedabout United with me, vital measures, you probably read about some of that inWall Street Journal.

And then, the comment that Steve made with regardingnetwork, I think needs to be underscored. Year-to-date, we have added a 190facilities and we have renewed contracts with 1,500 hospitals, most of themwith multi-year deals. So we feel very, very bullish about the stability andthe efficacy of our networks.

Stephen Hemsley

And if you really focus, our trend performance with respectto these large cases, this year has really been quite exceptional. So I dothink it is a function of execution on basics in terms of service, accountmanagement, flexibility and customer orientation.

And basically, some of the basics that Uniprise had usedvery effectively in their earlier years and we are basically returning to thatorientation. And I think that the market will respond as it has in the past.

Peter Costa - FTN Midwest Securities

And then on the Medicare side, is thisPrivate-Fee-For-Service now a focus area going forward or was some of thegrowth that we saw this quarter from the Group retirees side, can you talk alittle bit about sort of where you expect membership growth in Medicare?

Stephen Hemsley

Ken, you want to respond to that?

Ken Burdick

Well, Peter, your right that obviously, we did seeincreasing momentum in membership growth in this quarter with 95,000 newMedicare lives compared with 40,000 in Q2. Most of that growth on the MedicareAdvantage Fund came from our network-based offerings.

Going into 2008, as Steve said earlier, we have obviouslystrengthened our competitive position on Private Fee-For-Service and so areparticipating in 49 states. The Private Fee-For-Service has expandedgeographical coverage.

We are of course also though heavily committed to ournetwork-based offerings and new AARP-branded Medicare Advantage product and thesignificant expansion of our Special Need Plans from 7 to 34 markets.

So this is a broad-based approach to expanding our Medicarefootprint, recognizing that we participate in all of the Medicare productcategories and have a balanced revenue generation from those differentcategories of Medicare.

Peter Costa - FTN Midwest Securities

Thank you.

Operator

Your next question will come from the line of Justin Lakewith UBS.

Justin Lake - UBS

Thank you. Good morning. Couple of questions, just first afollowing up on the Medicare Advantage. Last year you gave us a membershipnumber and I think it was up 150 to 175. Did I miss it this year or are youwilling to talk about what you think about for Medicare Advantage next year?

Stephen Hemsley

You didn't miss it at all. We just have concluded that weprefer to go through the details of 2008 itself, as well as the discussion ofthe longer-term growth in the investor conference. So across the Board, wehaven't provided specific membership guidance for 2008. We think that will bebetter done in our discussions at the investor conference.

Justin Lake - UBS

Okay. And in regards to the Medicare AARP contract, is thereanything you can tell us as far as the changes in economics there. I believethere was a - you are going to be paying royalties on all of your HMO membersfrom beginning of the year. Is that correct?

Stephen Hemsley

Yes. I think that we basically have economics attached toall of those lives, all for the full year. Do you want to comment on that Bill?

Bill Munsell

The obvious impact is that we are going to go to the marketwith the only Medicare Advantage product, with the AARP name. And we think thatthat will be important as a trusted brand, not just for next year but over themedium-term as well, given that this is a contracted that gives us someexclusive relationship with the AARP on Medicare through 2014.

Justin Lake - UBS

Sure. I guess I was just curious if there was -- if you are payingout a fee for 2008 on all the existing members? Is there some break-even numberas far as the membership you need to gain through AARP in order to offset thosehigher costs, or did you may be do it to offset those costs through changes inthe benefit designs?

Stephen Hemsley

I don't want to get into detail of the economical side of whatwe believe over the life of this contract, this is going to make an importantcontribution to our ability to grow in the Medicare space and we believe thatthe trust embodied in the AARP and SecureHorizons names will serve bothorganizations well over that timeframe.

Justin Lake - UBS

Okay, great. And just one quick question on the commercialrisk side, the PacifiCare, can you break out the quarter-by-quarter, you've beentrying how to break out the PacifiCare, which wasn't at a commercial risks.

And I think last quarter you said, UNH on a standalone basishad actually grown. Can you give us those numbers for the first quarter and whatyou expect for this quarter and what you are kind of embedding in the 2008 whenyou say it is going to be down?

Stephen Hemsley

I felt we said that in total in this quarter, PacifiCarerepresented 70,000 of decrease of about a 140,000 in the risk-based book ofbusiness. So 70,000 for this quarter.

Justin Lake - UBS

And for the first of the year, can you tell me how manyPacifiCare members you expect to loose?

Stephen Hemsley

What, January of 2008?

Justin Lake - UBS

Yes.

Stephen Hemsley

There will be some fairly large cases that were insured andfrom our point of view not at all attractive from an economic perspective, butI don’t know if we are -- that we can actually predict what the number will begoing into January and which is why we stayed away from that subject.

Justin Lake - UBS

And you did say that that would be pretty much the end ofthe re-pricing of PacifiCare?

Stephen Hemsley

Dave Wichmann, you want to respond to that?

David Wichmann

Sure. Just a couple of things that 70,000 is the rightnumber and that makes the year-to-date PacifiCare repositioning to 270,000lives, which I think is important metric.

Justin Lake - UBS

Sure

David Wichmann

Leaving the underlying growth of our legacy business. So Iwant to make sure that we point that out. With respect to the large -- fewlarge case losses cases that we would have to write or rewrite at a loss, so wechose to not be as anxious for those as some others.

So there will be some of that in there. But it is entirelytoo early, particularly given the components of that block of business fullypredict what PacifiCare losses would be for January 1 or throughout 2008.

We caution on the repositioning of PacifiCare, this is ablock of business that at best was very modestly profitable and we have had todo a fair amount of repositioning with that business and that will continueinto 2008. And we have fully taken that into consideration in developing ourestimates.

Justin Lake - UBS

Great. Thanks for answering those questions.

Operator

Your next question will come from the line of Josh Raskinwith

Lehman Brothers

Josh Raskin - LehmanBrothers

Hi, thanks good morning. Two questions just on CR, I thinkwhen you guys announced it, you have said that it was $0.04 I just want tocheck if that’s still the right number for 2008?

And then just more broadly speaking on Medicare, could youjust help us understand sort of the strategy, I think some people are a littlesurprised by the bidding and I am not sure, how that came out versus yourexpectation from an industry perspective.

But, as you think about the next three to five years, andthat new earnings growth rate, what sort of contribution and where do you thinkthe Medicare growth is going to be?

Stephen Hemsley

I am going to handle the CR discussion.

Mike Makin

Hey Josh, Mike. We are not changing our curtness or ourassumptions with respect to the accretion for CR at this time.

Josh Raskin - LehmanBrothers

Okay

Unidentified CompanyRepresentative

With respect to the parties, I mean you want to respondthat?

Stephen Hemsley

Yeah. So your questions on the bidding was specificallyaround the dual eligible bidding limit, Josh?

Josh Raskin - LehmanBrothers

Yeah, I just think it, how you guys thought about Part Dcoming into 2008 and what was the impetus for the strategy that you guysbrought in terms of raising the bids? It didn't look like this year theprofitability was an issue in terms of the Part D and I know it's not brokenout specifically, but it is sort of curious what the thoughts were?

Stephen Hemsley

Yeah, let me take that in two parts. You think about ouropen market Part D positioning and then dual eligible Part D positioning. Asfar as our open market positioning is concerned, I think [DMS] just reportedthat the average Part D plan premium for 2008 will be $25 [PBM].

We have a range of plans in Part D market including ourvalue plan that has an average premium of just $22.17. If you think about theaverage premiums on our popular saver plan, they have only increased by 6.4%over two years during 2006 and 2008.So we think, we have bought some good valueofferings out are there in the market.

As far as the dual eligible piece is concerned, I think ourPart D group would rightly say that we have a very clear line of sight to theactual cost experience of these low income members, recognizing too that, thattends to be back left upside of mail or former incentives for this group. Andin the light of that is our usual practice, we took a disciplined approachpricing to our costs.

So the processes what to be is in the results, what theyare, as far as the few eligibility is concerned. Although as we previouslyreported the outcome is naturally negligible to us from an earningsperspective.

But more generally around the dual eligible bidding process,I would say that, I think the number of commentators pointed to some of thepublic policy challenges, obviously this methodology if it goes forward.

But it does appear to be generating more restricted form ofrisk for low income than the better off Part D members, and it appears thatsome of the low income members are about to be switched to alternative plans toinstruct formally exclusively together some of the top branded medicines totheir physicians who aren't prescribing it. I don't know if that comes out withthe Part D point. If you want to also pursue the sort of general Medicare.

Josh Raskin - LehmanBrothers

Yeah. That was perfect for Part D, I thought I understoodthe strategy there. No, I think but your point Simon maybe more broadly, becausejust overall on Medicare where you see that in terms of growth over three tofive years?

Simon Stevens

Yes, well, the sorts of things that we do particularly incoordinated Medicare Advantage, we think there is going to be strong continuingdemand for. If you think Josh, for example, Monday, this week, there was awidely publicized report from the National Cancer Institute, pointing thatthere have been encouraging declines in cancer mortality at 2.1% a year for thelast number of years and that's being driven by prevention and early detection.

If you then look at the Medicare population, what you see isthe type of programs that we offer through Medicare Advantage are exactly thosethat are required to contribute to that kind of improvement.

Medicare Advantage in the [longer view] right for exampleare around 60% compared with 46% in Fee-For-Service, colorectal screening rateis 70% in Medicare Advantage, that was 58% in traditional Medicare.

So the kind of clinical value added that we are bringing touncoordinated fragmented Fee-For-Service Medicare, I think is going to bevalued, regardless of the particular financing mechanism on top of thoseprograms.

Stephen Hemsley

And what we need to do is become more creative in terms ofdemonstration projects and initiatives to bring more ideas forward, becausethey are looking for those kinds of solutions that we have, the competency andresources to deliver on them. And that's why we are quite positive with respectto where these kinds of market can go long-term.

Simon Stevens

Yeah. I'd just say for example Evercare, which is now a $2.5billon company, there is absolutely no reason why Evercare can't double in sizein the next two to three years serving exactly this kind of market.

Stephen Hemsley

We are going to go for about 10 more minutes. So, we oughtto pick the pace on this. So, the next question please?

Operator

Your next question will come from the line of John Rex withBear Stearns.

John Rex - BearStearns

Thanks. I just wanted to focus back on the Ovations segmenta moment. I appreciate the difficult to get talking with precision aboutenrollment for '08, given that open enrollment hasn't kicked off yet.

But with your benefits all filed for your new MA plans for'08, wonder if you can give us kind of a relative magnitude of what youanticipate for margins, or if you want to say MCR's business. They clearly,they would appear to drop out very, very favorable so far this year.

And again, I know you don't give precision in terms of MCRson that segment, if you can give us some kind of order of magnitudedirectionally and how much you built in for cost ratio deterioration in thatbook based upon how your benefits were filed?

Unidentified CompanyRepresentative

Yeah, well, let me say this John. We feel about our 2008earnings prospects for several reasons, right trend and one time 2007 SG&Acosts that we are experiencing. Let me just give you a little more detail onthose. 2008 Medicare Advantage rates as we previously said reasonable which hasallowed us to have stable and strong benefits design going into 2008.

We are anticipating stable to modestly improving medicaltrends for 2008, which in part is thanks to our seniors who direct clinicalmodel. As you know we don’t act so fast regarding that was a critical corecompetent in the Medicare space.

Wealso expect meaningful gains next year in male penetration, in genericutilization across our Medicare businesses undertaking this process off withour new Part D benefit design that effectively provides members with genericdrugs for free. It’s supplied by mail and that way we are sharing these supplychain efficiencies with our members.

And of course we will continue to be properly compensatedfor the underlying health risk for the population we serve. That’s not aone-off event, that’s an ongoing process. So breakthrough reasonable medicaltrend, stable to modestly improving and then as we’ve already discussed inCharles question a number of one time SG&A costs that we were absorbing in2007 that we don’t expect to repeat at the same level in 2008.

John Rex - BearStearns

So just and I just want to clarify. So would that say thatyou anticipate your medical cost ratios and M&A to be stable in ’08 withthe’07 levels we’re seeing?

Stephen Hemsley

Well, as you know we don’t give guidance specifically on our[PCOs] and our Medicare portfolio, but I have just directed to you I think someof the factors that will drive that performance across the peak next year.

John Rex - BearStearns

Sure. And I guess I would step away from your commentssaying that, that kind of seem like general stability in MCRs. I Just want tomake sure I’m not over interpreting your comments.

Stephen Hemsley

Yeah

John Rex - BearStearns

Okay. And just you made one comment on -- Steve it wasinteresting to me in your cost trend outlook. I just want to clarify on theslight up tick in trend, you are taking about policy and evidence based careguidelines. Is there any additional detail on what’s driving that?

Stephen Hemsley

Breast cancer, testing protocols, there are couple ofothers, Ken you want to comment?

Ken Burdick

In addition to the revision in breast cancer screeningguidelines, which means that there will be a larger number of patientsconsidered high risk and therefore, receiving MRIs.

We've got several significant policy changes coming from theCMS, the Medicare eligibility as it relates to End Stage Renal Disease, increasingfrom 30 months to 42 months, will contribute to that up tick, as well as the MS-DRG.

And then finally one more point that I would add is thatremoval of the generic alternative to OxyContin has been factored into our costtrend projection. And all of these things have been factored into our pricing.

John Rex - BearStearns

Thank you

Stephen Hemsley

Next question please?

Operator

Your next question will come from the line of MatthewBorschwith with Goldman Sachs

Matthew Borsch -Goldman Sachs

Hi good morning and just wanted to say first it sounds likeyou guys are doing all the right stuff. Let me ask with regard to thecommercial fee-based enrollment outlook and I understand the market pressureson the commercial risk side of the business.

But, it’s obviously huge change for you guys to be talkingabout that being down in the first quarter of next year, beginning of 2006, Ithink in the first quarter you added close to a million fee-based lives.

Is that, looking back on it try to understand what happenedand how are you fixing it. Is that, would you, would it be fair to say thatcoming into to 2006 you had too many balls in the year in terms of large scalemerger integrations combined with the Medicare growth and did that distractedyou from some of the execution?

Stephen Hemsley

My believe that most of your writings have been very much onpoint on this and I would say correct, and that is we had, as we go into 2006,we had certain challenges with respect to our stock option programs and soforth, Part D was coming online, PacifiCare was coming online.

We were driving a great deal of change within ourorganization and I think that much of that has been addressed, and as you know,you don't really see the full impact of that until it really resonates in themarket for sometime.

And I think that you are going to see, I think there is someearly evidence of that and you are going to see continued evidence of a muchstronger, operational executional focus and base.

I'd add to that though, a reorientation back to customerfocus and basics that I think that we can perform much more effectively on interms of how we approach the marketplace, deal with consultants in themarketplace, deal with consultant audits, deal with customers, our level offlexibility, a whole variety of areas that I think that Uniprise was wellregarded for a few years back and we are putting in place in a absolutelyvigorous way going forward.

Matthew Borsch -Goldman Sachs

Okay. Sounds good. Thank you very much.

Stephen Hemsley

Thank you.

Operator

Your next question will come from the line of Greg Nersessianwith Credit Suisse.

Greg Nersessian -Credit Suisse

Hi. Good morning. Just a quick clarification and afollow-up. Did you say you are expecting a flat commercial MLR or did you saythe business that you are renewing your pricing at a flat MLR, in other worddoes that contemplate the higher cost PacifiCare business thing your re-pricingterm?

Stephen Hemsley

Mike.

Mike Mikan

Would you clarify the question, what period of time are youtalking about?

Greg Nersessian -Credit Suisse

In 2008, I think you said you are pricing for a flatcommercial MLR.

Mike Mikan

Yeah, we are pricing for a stable MLR on an internal basis.

Greg Nersessian -Credit Suisse

Okay. So that includes the contemplated re-pricing of thePacifiCare business and the other business that you are losing?

John Penshorn

This is John, Greg. You've got about 10 million members intotal there. So, that may be two fine of a question. I am not sure that youwould get detectable differences either way.

Stephen Hemsley

But I think the answer to that is yes. And it has been as wehave worked through the PacifiCare book and that I don't know if we have realprecision over what, how many cycles it takes to really, what I will sayreposition the book business like that, may be Dave Wichmann has a view of it.But that has been running through our numbers.

Greg Nersessian -Credit Suisse

Okay. That's okay. Maybe I will just take it off-line. Iguess my other question was just on the earnings, the quarterly earningsprogression next year. Would you say, that this year's earnings progression isa reasonable proxy for next year and I guess, on underlying the question is thejust the change in Part D risk quarter and is that going to impact theseasonality in your earnings progression for next year in terms of thequarters?

Stephen Hemsley

We are not giving greater guidance with respect to 2008 andI don't want to signal quarter-to-quarter progressions and so forth.

With respect to basic template of the business to be largelythe same, in terms of the broad make up of it next year. So, I don't want toconfirm that pattern, but I also don't want to give guidance on aquarter-to-quarter basis next year, until we have the investor conference inDecember

Greg Nersessian -Credit Suisse

Okay, fair enough.

Operator

Your next question will come from the line of ChristineArnold with Morgan Stanley

Christine Arnold -Morgan Stanley

Hi, there, just one last question from me here. On theSG&A ratio, kind of, as we look into 2008, do you see opportunities forimproving kind of your operating cost ratio and continuing to see improvementthere or do you feel like 2008 is an investment year with new products,recognizing that you do have some '07 cost that will occur?

Stephen Hemsley

Mike, maybe you want to answer that financially, and thenI'd have Dave Wichmann kind of come back, because I do think there are a lot ofopportunities in front of us.

Mike Mikan

A comparable mix of businesses we anticipate improving ouroperating cost ratio by 20% to 40% -- 20 to 40 basis points in any given year.And, so we believe if that to be true in next year, so we should see areduction of somewhere in that range on a year-over-year basis assuming thecomparable mix of businesses.

Stephen Hemsley

And Dave -- Dave has taken over kind of the broadoperations, you on an enterprise-wide basis want to comment on some of theelements of that?

David Wichmann

Sure, Christine. So leading that is really, productivityexpectations are improvement in productivity, which we see and that had beenable to demonstrate a year-after-year. I really look at kind of, though thereis a five primary areas of opportunity, obviously they'll be continuingconsolidation broadening in this marketplace over the long haul. So I wouldexpect that consolidation integration to drive greater scale efficiency.

We are very methodically and thoughtfully advancing ourintegrations. Right now we are very much into technology and operationalprocess conformance stage, and there we see great opportunity to leverage ourcommon platforms and processes in narrowing reduced cost, but also serve ourconsumers on a much more reliable and efficient basis. Not really look to thatfueling productivity in three to five years out or so.

One of things we haven't talked a lot about in the lastcouple of calls is our continued promotion of self service. And what we like tolook at it is that we offer a very flexible line-up of service option, selfservice being one of them.

In 2007, just by way of example we have to increased ourtransaction volumes on our portals quite considerably, consumer portal up 13%and I expect that to expand next year, now that we've achieved the number onerating on that portal again.

Our provider up a remarkable 26%, our broker up 12% andemployer while flat is in the re-tooling phase right now. So I'd expect that tocontribute greatly in the future.

In addition, I'll just touch on our EDI and auto-adjudicationrates, which are -- we believe to be fairly industry leading and are continuouslyperforming in the 80 plus percent range. So we're confident that that we'llcontinue to make advances in that area and improve our productivity as aresult.

I'd also just touch on process improvement, which not only,as Steve touched on it briefly in the script, but I want to bring it out alittle bit more, because I think it's a strong advance in health care.

When you get outside of your four walls and start reachinginto the supply chain more broadly. And we've done that with what we referredto as our HP3 program, which is essentially re-utilizing, re-manufacturing andSix Sigma techniques working with a large hospital systems through mediate kindof common issues that exist between payers and providers in this marketplace.And we expect to have 476 hospitals under this program by the end of the year.

And I think that you'll see that, that will not only improvehospital-based operations and performance, particularly around billing and cashapplication things of that nature, but it'll also improve ours as well and leadto the types of enduring relationships that Steve spoke up earlier.

Stephen Hemsley

Thanks, Dave. We're going to have to conclude now. So, Iknow there are other questions in queue and we will start to take them off-linevery actively. But we're going to have to close this. I will thank you. We willbe back quarter-by-quarter, stronger levels of operations, with solid growth,earnings. Thank you very much. Have a good day.

Operator

Ladies and gentlemen, that does conclude our conference fortoday. You may all disconnect. And thank you for participating.

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