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Aetna, Inc. (NYSE:AET)

Q3 2007 Earnings Call

October 25, 2007 8:30 am ET

Executives

Jeff Chaffkin - Head of IR

Ron Williams - Chairman and CEO

Joe Zubretsky - EVP and CFO

Mark Bertolini - President and Head of Business Operations

Analysts

Carl McDonald - CIBC WorldMarkets

Matthew Borsch - Goldman Sachs

Scot Fidel - Deutsche Bank

John Rex - Bear Stearns.

Josh Raskin - Lehman Brothers

Peter Costa - FTN Midwest Securities

Justin Lake- UBS

Bill George - J P Morgan

Matt Perry - Wachovia Capital Markets

Christine Arnold - Morgan Stanley

Charles Boorady - Citi

Operator

Good day and welcome to Aetna'sThird Quarter 2007 Earnings Call. Today’s conference is being recorded. At thistime I would like to turn the conference over to Mr. Jeff Chaffkin. Please goahead sir.

Jeff Chaffkin

Good morning and thank you for joining Aetna'sthird quarter 2007 earnings call and webcast. This is Jeff Chaffkin, Head ofInvestor Relations for Aetna and with me this morning are Aetna’sChairman and CEO, Ron Williams and Joe Zubretsky, Executive Vice President andChief Financial Officer. Following their prepared remarks, we will be pleasedto respond to your questions.

Joining us for the Q&A portion of this call is MarkBertolini, President and Head of Business Operations.

During the call, we will make forward-looking statements.Risk factors that may impact those statements and could cause actual futureresults to differ materially from currently expected results are described in Aetna's2006 10-K filed with the SEC.

Pursuant to SEC Regulation G, we have provided reconciliationsof metrics relating to the company's performance that are non-GAAP measures inour third quarter 2007 press release, third quarter 2007 financial supplementand our guidance summary. These reconciliations are available on the InvestorInformation portion of the aetna.com website.

Also, as you know, Regulation FDlimits Aetna’s ability to respond to certain inquiries from investors andanalysts in non-public forums, so Aetna invitesyou to ask all questions of a material nature on this call.

Now let me turn the call over toRon Williams. Ron?

Ron Williams

Good morning. Thank you, Jeff andthanks to all of you for joining us this morning. I am very pleased with Aetna's performance in the third quarter. Earlier thismorning, we reported operating earnings per share of $0.97 for the thirdquarter of 2007. This represents an increase of 15% compared to the thirdquarter of 2006.

Our success was driven by anumber of factors. We delivered solid top line growth, which we achievedthrough effective execution of our strategy. We had solid underwriting results,which were driven by disciplined pricing actions and favorable medical costsexperience, and we continue to achieve operating expense efficiencies while ourdisciplined capital deployment initiatives continue to yield positive results.

Joe will provide the details ofour third quarter results later in the call. What I would like to do ishighlight some of our important strategic initiatives from the third quarter.These initiatives are advancing Aetna'sefforts to win in the marketplace and position us for long-term profitablegrowth.

At Aetna,we talk about our strategy in the context of four dimensions; segmentation,integration, consumerism, and operational excellence. First, with regard tosegmentation, both at the customer and market level. We constantly are lookingfor new ways to more effectively serve our different groups of customers, whileidentifying opportunities in new markets.

As a result of our efforts thisquarter, we were able to achieve diversified, organic net medical membershipgrowth of 228,000 members. This brings Aetna’syear-to-date organic net medical membership growth to 562,000 members. And nowproject full year net medical membership growth of 600,000 to 650,000 members,which exceeds our prior growth expectation of 575,000 to 600,000 members.

Including our acquisition of SchallerAnderson, which closed on July 31, total medical membership at the end of thethird quarter has grown to 16.6 million members. During the quarter, we tookimportant steps to execute our segmentation strategy to expand and diversifyour business. Specifically, we expanded our individual profit into fiveadditional states as we continue to focus on the 47 million people in Americawithout insurance.

We are creating workablesolutions for the different segments of the uninsured population, and Aetna nowoffers products for individuals and their families in 24 states and Washington D.C.We have very strong membership growth in the third quarter in Aetna’sGovernment and Labor sector and in the Student Health market, demonstrating thevalue of our diversified product offerings and distribution capabilities.

Another strategic accomplishmentin the area of segmentation was our acquisition of Goodhealth Worldwide, whichclosed on October 1. Goodhealth Worldwide is a leading managing general underwriterfor international private medical insurance covering approximately 56,000members. Goodhealth offers expatriate benefits to individuals, small and mediumsize companies and large multinational clients around the world. BroadeningAetna Global Benefits expatriate offerings and significantly enhancing ourglobal capabilities and reach. In addition, this acquisition combines Aetna’s strength in US, [to our] benefits plans withGoodhealth’s deep knowledge on the European benefit designs.

One final segmentation highlightduring the quarter was our announcement of the formation of our MilitaryHealthcare Advisory Committee. This committee will help guide as we consideropportunities to grow our business relationships with the federal government,including our potential bid for Department of Defense’s TRICARE health plan.Integration is the next dimension of our strategy. The integration of ourproducts and services delivers a strong value proposition to our customers,which in turns results in new cross sale and revenue growth opportunities.

Increasingly, we are makingmultiple product sales and in the third quarter we continued to generatemembership gains across our specialty products of pharmacy, dental andbehavioral health. Pharmacy membership increased by 83,000 in third quarter,commercial dental added 93,000 net new members, and in behavioral health weincreased membership by 156,000 members.

The value of integration goesbeyond simplified administration. By integrating medical pharmacy, dental andbehavioral health along with our industry-leading Active Health medicalmanagement capabilities and proprietary technologies, we can help providersfavorably impact the clinical outcomes for our members. Aetna’sinnovated and unique medical management products continue to attract stronginterest and drive profitable growth. In fact, as of September 30th, 15.6million members are benefiting from Aetna'sActive Health care engine.

In addition, our Personal HealthRecord is resonating in the market. This quarter we announced that as ofJanuary 2008 every federal enrollee who selects an Aetna Medical Plan will gainaccess to our care engine powered Personal Health Record. This type ofinnovation has enabled Aetna to have thehighest percentage membership growth across all federal health plan offeringsduring the past four years.

Consumerism is another keydimension of our strategy. We continue to advance Aetna'sleadership in consumerism by introducing new tools and capabilities andincreasing membership and our consumer-directed health plans. For exampleearlier this month we announced the launch of a new web-based resource thatfurther expands our cost and quality transparency initiative.

Beginning next month Aetnamembers in certain locations will be able to use our Aetnanavigator online tool to review total expected cost for more then 30 commonmedical procedures. This unique approach will allow consumers to compare totalprocedure cost by selecting different combination of procedures, physicians andfacilities. With all of Aetna’s transparencyinitiatives our intent to support informed consumer decisions by offeringappropriate detail on cost and quality.

We expanded our membership inconsumer-directed health plans to a total of 980,000 members at September 30th,which represents growth of 304,000 members year-to-date. Additionally we are ontrack to expand, excel Aetna’s performancebase network to a total of 35 markets effective January 1st 2008, representing73% of our existing membership.

Operational excellence is thelast dimension of our strategy. Operational excellence is embedded ineverything we do. The three financial metrics that best demonstrate ouroperational vigor and accomplishments are the medical benefits ratio, theoperating expense ratio, and our pre-tax operating margin. For the thirdquarter our commercial medical benefit ratio of 78.6% reflects solidunderwriting discipline and our focused efforts in the area of medicalmanagement. Importantly, we view the medical cost environment is stable and wecontinue to project our medical cost trend at 7.5% plus or minus 50 basispoints for the year

Furthermore, our operatingexpense efficiency continues to improve. We achieved a 20 basis point declinein our operating expense ratio to 18.2% in the third quarter of 2007 comparedto the prior year quarter. We’ve demonstrated consistent progress in reducingour cost as a percentage of revenue even as we continue to make investments toprofitably grow our business and enhance our technology infrastructure. Thecombination of solid underwriting results and operating efficiency lead to apre-tax operating margin of 12.1% for the quarter, an excellent resultdemonstrating our commitment to profitable growth.

Now turning to our outlook forthe future, I am confident in our ability to continue to deliver top tierperformance while successfully meeting customer needs for the balance of 2007and in 2008. We now project our full year 2007 operating earnings per share tobe $3.48, an increase from our prior guidance of $3.40 to $3.42 per share, andnow represents 20% growth year-over-year.

In addition although we have notfinalized our 2008 plan, and our new business selling season is still underway,we are very optimistic about our growth prospects. While there are competitivechallenges in the fee based commercial market, and a constant need to reinvestin the business; we believe our diversified customer segment focus model alonewith our capital deployment strategy will enable us to deliver another year ofstrong profitable growth for Aetna.

For 2008 regarding membership,our momentum continues from our strong 2007 growth. In the government and laborsector, we already have several important wins for 2008. These include the cityof Anaheim and the city of El Paso, as well as a large governmentaccount which is converting from a self insured to a fully insured Private Feefor Service arrangement.

In National Accounts, we werevery successful in winning new business for 2008. For January 1, new business,we expect net additions of at least 200,000 new medical members. And ourpipeline includes additional opportunities. Our sales successes include 19 newaccounts, growth from existing accounts and opportunities presented to usthrough the endorsement of the HR Policy Association. The market place feedbackwe have received has been very positive.

Aetnahas set itself apart from the competition by consistently focusing on a best inclass customer experience. Providing differentiated consumer oriented productsand tools and delivering a truly integrated value proposition.

Overall for 2008 we expect netmedical membership growth of at least 300,000 members in the first quarter andexpect full year membership growth to be in excess of 650,000 with furtherupside possible given the strength of our pipeline.

Our guidance for 2008 operatingearning per share is $4, consistent with our long term target of 15% growth.This is an early view of 2008 and we look forward to updating you on our fourthquarter call in February.

In summary, I am very pleasedwith our results for the third quarter, as well as the numerous marketplacesurveys that have recently validated our efforts. We are enthusiastic about2008 and expect another year of profitable growth. I would like to thank ouremployees across the country and around the world for their unwaveringdedication to meeting our customer’s needs. It is through their efforts that weare able to continue our success in 2007 and beyond. Now I will turn the callover to Joe Zubretsky, who will discuss our financial performance for the thirdquarter and provide additional detail regarding our outlook for the reminder ofthe year and 2008. Joe.

Joe Zubretsky

Thank you, Ron, and good morning.Earlier this morning, we reported after-tax operating earnings of $507.4million for the third quarter of 2007 or $0.97 per diluted common share. Thiscompares to $466.3 million or $0.84 per diluted common share in the thirdquarter of 2006. This represents increases of 9% and 15% respectively.Operating earnings from our three reporting segments totaled $536 million, a 9%increase over the prior year. If you exclude the effects of favorable priorperiod reserve development, Aetna delivered$0.94 per diluted common share in the third quarter of 2007. That result is$0.02 above the upper end of our guidance range. Aetna’sthird quarter results include the impact of the Schaller Anderson acquisitionwhich closed on July 31. This acquisition adds more than $600 million ofprofitable revenue on an annualized basis.

For the third quarter of 2007however, Schaller Anderson did not have a material impact on our operatingearnings or net income. I will note, with the inclusion of this acquisitionimpacts operating metrics.

Net income of $496.7 millionincluded $10.7 million of after-tax realized capital losses. This reflectedinterest rate related market value adjustments on a portion of our investmentportfolio which was off set by net gains from securities transactions. Ourdiluted weighted average share count of 523.9 million shares represents a 6%decrease compared to the prior year quarter due to continued share repurchaseactivity.

Regarding the operating earningsfrom our three reporting segments, for the quarter operating earnings in ourHealth Care segment were $488.6 million, an increase of 9% over the thirdquarter of 2006 driven by strong underwriting results. Operating earnings inour Group Insurance segment were $38.2 million, 10% higher than the prior yearquarter, and the Large Case Pension segment operating earnings were $9.2million, 13% lower than the third quarter of 2006.

I will organize my comments onthird quarter result by the key drivers of our financial performance. First,managing toward target margins; second, investing in profitable growth andthird, creating excess capital and deploying it accretively. I will thenconclude with our outlook for the remainder of 2007 and 2008.

Let me first address ouroperating margin performance in the third quarter of 2007 and its keycomponents revenue, health care cost trend, and operating expenses. The combinationof solid underwriting results and improved operating efficiency led to anexcellent pre-tax operating margin result in the third quarter. The $507.4million of after-tax operating earnings were $775.9 million on a pre-tax basisrepresents a pre-tax operating margin on consolidated revenue of 12.1%. Thisresult demonstrates management discipline across all aspects of our business,including pricing rigor, health care cost management and operating expensecontrol.

We continue to deliver on ourplans for profitable growth. Our strong top-line growth is a result of solidmembership increases, disciplined pricing actions and contributions fromacquired businesses.

Consolidated revenues increased11% in the third quarter, from $6.3 billion in 2006 to $7 billion in 2007, withHealth Care segment revenues increasing 12.5% year-over-year or 10.6% if youexclude Schaller Anderson.

Premiums in our Health Caresegment increased by 13% year over year, 11.5% excluding Schaller Anderson withour commercial premium increasing by 8.5% and Medicare premiums increasing by35%.

Specifically, the growth incommercial premiums was driven primarily by disciplined pricing actions, whichwere in line with the medical costs trend, substantiated by our reportedCommercial Medical Benefit Ratio. Weight and volume contributed approximately6% and 5% in the premium growth offset by mix of approximately 3%.

We continue to reap the benefitsof expanding our Medicare footprints with both individual and group Medicareexpansion efforts, fueling year-over-year premium growth in that business.Third quarter Medicare advantage membership is 54% higher than the year agoquarter based on membership gains achieved in the first quarter of 2007capitalizing on Medicare Private-Fee-for-Service opportunities.

Third quarter 2007 consolidatedfees and other revenue of $775.9 million increased 9% over the third quarter2006, 4% if you exclude Schaller Anderson, driven primarily by membershipincreases and slightly higher per member, per month fees.

Turning to our health care costexperience in the third quarter 2007, Aetna'sCommercial Medical Benefit Ratio was 78.6% in the quarter, the same result weproduced in the third quarter of 2006. Our Medicare Medical Benefit Ratio was84.4% in the quarter compared to 80.7% in the year ago quarter. And our totalMedical Benefit Ratio, which includes our commercial Medicare and Medicaidproducts, was 79.4% in the third quarter of 2007 compared to 78.8% in the prioryear quarter.

These favorable results reflectour forecasted seasonal pattern of medical utilization as well as our continuedability to maintain pricing in line with medical cost trend.

With respect to our commercialproducts, it is important to note that in the third quarter of 2006, there were$33 million of favorable prior period development on a pre-tax basis. Inrelevant year-over-year comparison of the Commercial Medical Benefit Ratio uses78.6% for this quarter as reported and 79.3% for 2006 as adjusted for thefavorable development. Our Commercial Medical Benefit Ratio results demonstratethat we have accurately forecasted medical trend, helped our customers manageit and successfully price for it.

Our Medicare product line is nowprojected to outperform our previous expectations primarily in the PrivateFee-for-Service product. As a result, our operating earnings for this quarterreflect favorable prior period reserve development of $24 million on a pre-taxbasis related to the first half of 2007. This accounts for 380 basis points in theMedicare Medical Benefit Ratio and as such the adjusted ratio of 88.2% was inline with our expectations. Our reserving practices remain consistent andappropriate and we ended the quarter with a prudent level of reserves.

Our health care cost reserves stoodat $2.2 billion at September 30th. Days claims payable were up 0.9 days to 46.3days for the quarter and excluding the acquisition of Schaller Anderson ourdays claims payable were comparable to the second quarter of 2007, andconsistent with our expectations.

Our full year view of medicalcost trend is that it is stable in consistent with our prior quarter guidanceof 7.5% plus or minus 50 basis points. Major health care cost categoriescontinue to be in line with our expectations and we continue to see moderatetrends across cost categories. Specifically inpatient costs are trending at midto high single digit growth rates, outpatient at high single digit to lowdouble digit rates and physician and pharmacy costs at mid single digit growthrates with some upward pressure on pharmacy trend for 2008 due to the impact offewer new generics coming into the market.

The third key component of ouroperating margin results is operating expanse efficiency. We continue torealize efficiencies during the quarter and achieved an operating expense ratioof 18.2% representing a 20 basis point improvement compared to the prior yearquarter. This improvement comes despite of 20 basis points increase from theSchaller Anderson acquisition due to its service revenue based profile.

We continue to leverage our fixedcosts by growing revenue in core markets and products, driving down unit costswith technology and business process improvements, all while investing forfuture profitable growth through new product platforms, market expansions, andnew system capabilities.

Specifically, during 2007 and inthe third quarter, we’ve invested in operational platforms related to our HRPolicy Association partnership in AARP business, our TRICARE initiative,enhanced disease management programs and Aetnabrand awareness.

The second driver of ourfinancial performance is investing for profitable growth. I would like to talkabout Aetna’s growth prospects and providemore detail on our third quarter membership growth.

During the quarter, we grow ourmedical membership organically by 228,000 members with inclusion of SchallerAnderson's approximate 618,000 members, our medical membership were 16.6million as of September 30. Our segmentation, expansion and diversificationstrategies continued to gain traction and contribute to our profitable growth.

For example, we achieved stronggrowth in both insured and self-insured membership during the quarter. Of the228,000 members we added organically, 133,000 were insured members and 95,000were self-insured or ASC members.

We continue to expand inattractive growth markets in the third quarter and experienced organic medicalmembership growth in each of our six regions. Our growth in the West andNorth-central regions was particularly strong. We also realized meaningfulgrowth from our key and select account customer markets and our individualmarkets.

The Government, Labor and StudentHealth markets contribute over 50% of our net organic medical member growth inthe third quarter. Our Student Health market added 43 new accounts, achievedretention rates of 95% and had sales successes including the Arizona StateUniversity system and the [Ruckers] account, New Jersey which provided accidentonly coverage to 37,000 full time students

The third and final area offinancial performance I‘ll comment on, is our management of capital and itsaccretive deployment. This includes our cash flow dynamics, our holding companyliquidity, how we deploy that liquidity in the quarter and our capital structure.

Our third quarter 2007 operatingcash flow measured on a GAAP basis for health care and group insurance was$382.4 million. This represents 78% of GAAP net income for the quarter as onlytwo payments rather than the normal three were received from CMS for Medicarereimbursements. This was expected and is consistent with our previous commentsearlier this year related to receiving an extra CMS payment during the firstquarter.

Year-to-date operating cash flowis $1.7 billion or 128% of net income. In the third quarter, we generated $318million of holding company cash flow. We also issued $535 million of commercialpaper, which remained outstanding as of September 30. This capital generated inthe third quarter combined with our June 30th liquidity position of $515million, resulted in $1.4 billion being available for share repurchases andfunding of acquisitions.

Our primary uses of holdingcompany liquidity during the quarter were financing the Schaller Andersonacquisition for approximately $535 million and repurchasing 14.3 million of ourshares in the open market for $716 million. We used the remainder of our April2007 Board authorization to purchase shares and obtained additional sharebuyback authority of $1.25 billion at the end of September. Our basic sharecount was 500 million shares at September 30, down from $511 million at June30.

At the end the third quarter, wemaintained $202 million of holding company liquidity. Our capital position issolid and as a result of issuing the commercial paper noted previously, ourtotal debt to total capitalization ratio is approximately 24% just below ourtarget of 25%. We are planning to term out these short-term borrowings withlong-term debt. In fact, during the quarter we locked in the underlying treasuryon a portion of our anticipated long-term borrowing.

While we are not comfortable witha total-debt to total-capitalization target ratio of 25%, we would considertaking additional capital actions over the next 12 to 18 months to increase ourtarget up to 30%. This could include the issuance of hybrid securities. Theseactions would serve to reduce our weighted average cost of capital, enhancedreturns on common equity and diversify our funding sources.

Regarding capital deployment, ourpriorities continue to be to finance organic growth, finance strategicacquisition, and repurchase our own shares. Disciplined evaluation of inorganicgrowth opportunities remains an important element of our strategy for achievinglong-term profitable growth. And we continue to maintain an active M&Apipeline.

Our acquisition criteria remainsfocused on enhancing our operational and product capabilities, managing medicalcosts and improving quality as well as expanding our market breadth consistentwith our strategic objectives of local market density, medical cost management,innovation and customer market segmentation.

Before we move to the Q&Asession, I would like to provide some additional guidance for the remainder of2007 and our expectations for 2008. Given another strong quarter of financialand operational performance, we have increased confidence in our ability tosustain this momentum for the remainder of the year.

To be specific, for the full year2007, we project medical membership growth to be 600,000 to 650,000 members,which supersedes our prior expectation of between 575,000 to 600,000 net newmembers.

Double digit Health Care revenuegrowth; a commercial medical benefit ratio of less than 80%, with a totalmedical benefit ratio of less than 81%. A medical cost trend of 7.5% plus orminus 50 basis points, a premium yield that is inline with medical cost trend,and operating expense ratio showing a 60 basis point improvementyear-over-year, 80 basis points excluding Schaller Anderson, a pre-tax operatingmargin that is stable to slightly higher than 2006 and operating earnings pershare of $3.48, which is based on a 528 million diluted weighted average sharecount.

We are projecting fourth quarteroperating earnings per share of $0 87 in the commercial medical benefit ratioto be in the range of 79% to 79.5%. Fourth quarter operating earnings per sharewill reflect the increase costs associated with ramping up operationally forour expected strong January 2008 membership growth.

For the full year 2008, we expectsolid profitable membership growth in excess of 650,000, a double digitincrease in healthcare revenue, a stable commercial medical benefit ratio, withthe total medical benefit ratio expected to rise, due to anticipated aboveaverage growth in our Medicare business, continued attention to operatingexpense efficiencies with overall improvement similar to the 2007 level.

While we expect the overalloperating margin environment to remain stable, the reported pre-tax operatingmargin is likely to decline modestly in 2008, primarily due to the impact ofgrowth in Medicare and the full year impact of our acquisitions.

In addition, we expect tocontinue to use Holding Company cash flow to repurchase shares, absence anyacquisition opportunities. All of these components lead us to our operatingearnings per share outlook of $4, representing 15% growth over our newlyincreased 2007 earnings per share guidance of $3.48.

In summary, we are very pleasedwith our result this quarter along all three dimensions of our financialperformance; managing to our target margins, investing in profitable growth andaccretive capital deployment. We remain confident in our ability to deliverprofitable growth in 2008 and beyond. With that, I will turn the call back overto Jeff. Jeff

Jeff Chaffkin

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

Question-and-Answer Session

Operator

Yes. Thank you. We'll take ourfirst question from Carl Mcdonald, CIBC.

Carl McDonald - CIBC World Markets

Great, thank you. In terms ofthinking about the 2007 outlook, you mentioned a slight uptick in pharmacytrends. Maybe you could flush out what you think the pricing and cost and youroutlook for next year will look like?

Joe Zubretsky

Well, in terms of the medicalcost trend, what we have been indicated is that the medical cost trend will bestable roughly in the 7.5% range plus or minus 50 points, and we would expectthat we will continue to price in line with our medical cost.

Carl McDonald - CIBC World Markets

Okay, so, no significant changesthen in either?

Joe Zubretsky

No.

Carl McDonald - CIBC World Markets

Alright. And then on the employeeretiree, you highlighted that one account that will be added on January 1.Could you size for us what you think the potential growth in the employmentmarket will look like next year and what you think the overall size of thatmarket is for Aetna?

Joe Zubretsky

Well I will talk at the strategiclevels as we say it, in terms of ‘08 we will give a lot more color when we getinto the fourth quarter call. But what we have said is that we believe that thenational council has at least 200,000 members in the National account segmentsin the first quarter.

Overall we see about 300,000 netmembership growth in Q1. But I think that the main focus for us is really howthis segmentation strategies is working. I will ask Mark to give a little colorin terms of kind of what he is seeing broadly in the marketplace and how we’rewinning relative to our competitors.

Mark Bertolini

Yes, Carl, particularly relatedto the National Account business, as we go into 2008, we’re seeing stronginterest in Medicare private fee for service for the retire populations isimportant, as we look for a way to control cost going forward for the retires.And even more so on the government and the labor sectors to the marketplacewhere GASB has required that local and state governments now begin to recordthe retiree liability associated with their healthcare cost going forward. And,so we have seen a lot of interest there. We continue to talk with a lot ofaccounts. These accounts take a while to make a decision, and so we don’texpect a lot of overwhelming activity in 2008, but we are seeing the beginningof a fairly strong pipeline and are working on that pipeline aggressively.

Carl McDonald - CIBC World Markets

Relatively to the roughly 70,000Medicare lives you have added this year, do you think directionally, or on anabsolutely basis that number would will higher or lower in 2008?

Joe Zubretsky

I would say directionally higher.

Carl McDonald - CIBC World Markets

Great. Thank you.

Operator

We will go next to Matthew Borsch, Goldman Sachs.

Matthew Borsch - Goldman Sachs

Yes, hi good morning. I’mwondering if you could just comment on your view of the contract in growth inyour commercial risk book. If we are comparing what we saw from Aetna in this quarter versus a couple of the other majormanaged care companies that have reported. And maybe if you get into that, canyou sort of give us a sense of how much of the growth in the commercial fullyinsured segment was driven by new segments in new markets versus your sort oflong standing existing markets?

Ron Williams

Good morning Mat. I think the difference in terms of ourstrategy and I will leave it to our competitors to explain their strategy, themain thing that we have tried to do -- I can't tell if I am coming out with anecho there, we're getting one on this end.

Matthew Borsch - Goldman Sachs

It’s on not this end.

Ron Williams

Okay. Thank you. The main thing that we have tried to do isreally apply classic consumer market segmentation approaches to find coverts ofcustomers who have distinct needs and distinct purchasing habits and desiresand then build businesses around that. And I think, Mark will take you throughexactly where the growth is coming from, but I think what's different about ouroperating model is this really disciplined approach to consumer segmentation atthe plan, sponsor and decision level and doing it consistently across anintegrated operating model. We're one company. We have a very tightly nationalintegrated operating model also so that we have the ability to quickly defuseinnovations across the country. So, if we find something that works in onegeography, we can quickly replicate that across our six other regions becauseof the way that we are organized and how tightly we are integrated as anorganization.

Matthew Borsch - Goldman Sachs

Got it.

Mark Bertolini

Good morning, Matt. Let me take you through a few points,first relative to the geography, we grew in all regions in the quarter from amembership standpoint. So, we aren’t growing in any specific region versusanother. We tend to be growing faster from a pure percentage basis obviouslybecause of the size in the new geographies that we have opened up. But wecontinue to expand geographies; eight new geographies and individuals, threegeographies in small group, group and individual market openings for Medicareboth on the PFFS and on the Medicare Advantage basis. So, from a geographicstandpoint continue to look for market opportunities to grow that is supportedby some of the acquisitions we have done over the last few years relative tobuilding local market strength with the provider community in being able todevelop rates of a marketplace that are competitive from a standpoint of whereour competitors are.

But that's not the only place we do it. The end marketswhere we have traditionally been, we opened up new segments of the market. Sothe individual marketplace has gone from 3 to 31 markets over the last threeyears as we have expanded the segment into additional markets where we havetraditionally only had small group of middle market and national accountssegmentation. In addition, we continue to grow our Student Health business, so newsectors of the market. And then finally we begin to look at differentdemographics in marketplaces like the Asian American community, the HispanicAmerican community and develop product offerings that specifically benefit plandesigns but network offerings and distribution channels that best serve thesecommunities, including the types of sales people and service people we hire tosupport that growth.

Matthew Borsch - Goldman Sachs

If I could just ask one quick related follow-up, would yousay that you are seeing may be an easing of the competitive pressure overallalthough I am sure its highly variable from market-to-market versus may bewhere we were a year ago and then…yeah sorry go ahead.

Joe Zubretsky

The one thing you can tell from our competitors’ reports isthat the competitor pressures in the marketplace still exist and it’s how weexecute in marketplace that makes the difference.

Matthew Borsch - Goldman Sachs

You alluded to competitive challenges in the fee basedsegment that was sort of seem to be a little bit of a new reference, is thatthe area of business where you are seeing the most intense competition?

Ron Williams

Yeah, I would say that that is both a cyclical activity aswell, that is, cases go out to bid. They did have a traditional relationshipfor a period of time. When they go out, you do see a market check that doesintroduce a new competitive bidding dynamic into the process. I think I wouldrepeat what I would say, historically as the business is always competitive, thelocus of that competition changes from segment to geography to differentelements of the business. But it is competitive and it has been competitive andwhat we are doing is winning in the commercial market by doing a better job oflistening to our customers, understanding what they need and then doingsomething about it by developing solutions that gives them practical reasons topick us versus our competitors.

Matthew Borsch - Goldman Sachs

Great. Thank you.

Operator

We are going next to Scot Fidel, Deutsche Bank

Scot Fidel - Deutsche Bank

Thanks. Good morning. First question, if you can maybe spikeout what your individual customer growth was in the quarter? And then also justin terms of the increased 2007 enrollment guidance, maybe break that down intowhich customer segments are driving the increase there?

Ron Williams

Yeah. We haven’t really talked about specific growth at thesub-segment level. What I would say, to try to give you a directional elementis that the individual has been a steady contributor to growth this year, aswe’ve opened a new market. It’s not a predominant source of growth but againback to our strategy is, we are getting good steady growth in lots of discreetsegments, and it would be one important contributor.

Scot Fidel - Deutsche Bank

Okay. And then just a follow up around the Medicaid businessnow that you have Schaller onboard,maybe if you can talk a bit about expectations for 2008, sort of an update onyour expected accretion from that? And then, also some of the new markets whereyou might see opportunities to grow in Medicaid and specifically South Carolina and someof the new TennCare markets, your thoughts on bidding there?

Ron Williams

Well, let me talk just a little about the strategy, one ofthe reasons we selected Schaller as the partner, we wanted to work with was wethought they had a great franchise and did represent a very compatible culturein terms of a very strong emphasis on medical management and really put incustomers at this centre and what they do. What we are looking at and are doingis how we can build on their capability in markets where we are strong. Anexample would be the implementation that we have underway in Indiana, it's about a 42,000 memberimplementation that will be effective in ’08. It is a medical managementcontract as opposed to risk contracts, much to our ASC fee income.

I think we would talk in more detail about what we wouldexpect in ’08 as we get into the next earnings call. But I think we feel verygood about where we are. We feel like it has been a very solid acquisition forus. It was a very good team, good cultural fit, and very positive customerfeedback, both from their customers in states that had asked us about ourinterest in helping them address their uninsured problem through use of Medicaid.

Scot Fidel - Deutsche Bank

And you still see that contributing $0.03 for next year?

Joe Zubretsky

Yes we do.

Scot Fidel - Deutsche Bank

Okay, thanks.

Operator

We will go next to John Rex, Bear Stearns.

John Rex - BearStearns.

Hi good morning. I have question on Medicare, your med costratios in Medicare is running in line with your expectations in the high [8s]but meaningfully above what we are seeing from the rest of the industry andjust as you look towards ’08 and you are benefit design you incorporated for’08 in it, do you anticipate improving those margins or is your target tomaintain at that MCR level, I guess, in terms of what kind of opportunities yousee there?

Joe Zubretsky

John, this is Joe Zubretsky. Right now, the Medicare BenefitRatios that we are experiencing are at target levels and they will not changemeaningfully in our 2008 plan.

John Rex - BearStearns

Okay. So you would be still happy in that level. Good and then also, Joe -- I am sorry if Imissed this. What would the share count assumptions you had for ’08 or how muchrepurchase were you incorporating in your EPS?

Joe Zubretsky

We haven’t given any specific guidance on share count, John,but based on this year's earnings level which creates next year's dividendcapacity, we have fully baked that into our $4 per share estimate. So, you canassume that the 2008 plan contemplates a meaningful level of share repurchase.

John Rex - BearStearns

Okay. It’s kind of a bit of a departure from your guidancein prior years of that, your initial guidance, is that correct?

Joe Zubretsky

You know when your business throws off a $1.2 billion to$1.5 billion a year, having a plan that has it sitting ideally in cash we areassuming an acquisition, doesn’t make too much sense. So perhaps this is adeparture from past practice, but I think it’s the right one. That is the basiccapital plan. It would be to repurchase shares and then measure acquisitionactivity off of the accretion of a share repurchase

Ron Williams

And John I would remind you that our 2008 plan while it’s atthe very tail end of being finalized has had not yet been concluded andapproved by our Board.

John Rex - BearStearns

Okay great. Thank you.

Operator

We’ll go next to Josh Raskin, Lehman Brothers

Josh Raskin - LehmanBrothers

Hi, thanks. Good morning. First question just around some ofthe newer segments in terms of focus areas of growth. You mentioned a lot theStudent business, the Labor, and Government segments and then maybe even thepart time business, we have heard a lot of other players now entering thosemarket. I was just curious if you are seeing any changes in the competitivedynamics, it didn't sound like the Students business was impacted, but just curiousto hear what sort of competitive pressure are you seeing?

Mark Bertolini

Josh, this is Mark Bertolini. I would say that depending onthe segment for example an individual as we go and then expand markets and asour competitors realize we are growing in those markets we see some reaction,however, because of the portfolio we offer it’s difficult for them to reactacross the board. So, in some instances in markets where we’ve been challengedin the small group segment where we have been introduced to individual, it'sbecome a hedge both competitively and growth wise in that marketplace for usfrom the standpoint of our competitors being able to single in on any singlesegment of our business.

In addition, individually as we grow tends to have some ofthat aspect, small group really not a whole lot of impact. We continue to seethe competitive markets that we've seen in the past are largely with theregional blues. In the national account sector, I would say that we have seenbecause all of the major national players are healthy that we've seen arelatively competitive marketplace there, but no more than it was last year.

Josh Raskin - LehmanBrothers

Okay. That's helpful. And then just more of a managementquestion, there has been a lot of management [talk] broadly speaking in theindustry, but Aetna has had a couple of mergers as well, so just any thought interms of organizational structure, maybe from Ron if you anticipate any changesin the next year or so and then maybe specifically Craig Callen's departure?Should we read into anything, you know, a real matter around the M&Aopportunity in future?

Ron Williams

I would say that one of the things we feel very strong aboutis, we have a very strong advantage is that we have a lot of long-term talent.We have very rigorous succession planning and talent development process,that's something that I personally and the executive committee of the companyhas spent a good deal of time on being certain that we are developing the nextgenerations of people who really understand multiple facets of the business,really understand different customer segments and really understand our uniqueoperating model and the culture of the company and how we expect to win longterm strategically.

So from our point of view, you always hate to lose goodpeople, but you see normal comings and goings. I think Craig was a veryimportant contributor to our success. He has chosen to do some other things. Wecertainly wish him well. He's been a great colleague and a partner. I think ourstrategy is a strategy that I and the executive committee have really beenactive participants in developing and you should expect that we will continueto execute our strategy as you have seen it unfold over the past several years.

Josh Raskin - LehmanBrothers

Okay. That's great. Thanks.

Operator

We will go next to Peter Costa,FTN Midwest Securities.

Peter Costa - FTN Midwest Securities

Hi, can you talk a little bitabout the Good Health acquisition, and in particular if you can quantify sortof the cross-selling opportunity of its products to your current account base.And then if you have started to explore selling to its account base some ofyour products.

Ron Williams

Yes. Good morning, Peter. TheGood Health acquisition for us was a very exciting opportunity to build on afranchise that we have been growing very successfully which is the expatriatemarket principally targeted toward US corporations who are increasinglybecoming international and having more of their work force operating around theglobe. What we had an excellent capability to do, was to interface with USstyle benefits and yet connect them through healthcare delivery systems that wehave established in other countries so that they can get the care they neededthere or be brought back to other locations to get more complicated andextensive care.

The exciting part about GoodHealth is it gives us the capability to dock with the European style benefitplans. And so for us, it opens up the compliment of the US companies which arecompanies headquartered in Europe and other parts of the growth, Asia, where wecan take their expatriates who are moving around the globe and offer them avery complimentary service. So it really gives us a global solution. It alsobrought us capability that was targeted toward a smaller end of the market aswell, and they also do have some individual capability targeted principally tohigh-net-worth individuals who tend to be kind of global citizens who travelaround quite a bit. And so for us, it is very exciting. We think that it willgive us some good growth opportunities and help us really follow our customersin the context in meeting their needs.

Peter Costa - FTN Midwest Securities

Okay. Thanks and then a follow–upon the Group Retiree business. Can you quantify what you have sold today interms of group retirees and what do you expect that to acquire for next year?

Ron Williams

I don’t know that we havequantified it specifically year-to-date. But I think, the way I would probablytry to answer at it is, that if you look at -- I would say let us get back toyou on that if we would and I don’t that we have talked about it specifically.We have given some color on accounts and we try to say directionally it hasbeen some what important this year and more important next year. And what Iwould probably say is, stay tuned in February and we should give you moredetail and color.

Peter Costa - FTN Midwest Securities

Alright, thank you.

Operator

We will go next to Justin Lake,UBS

Justin Lake - UBS

Thanks. Good morning. The firstquestion is on the commercial MLR, it looks to be running significantly betterthan expected, obviously seeing solid cost around. So, I am wondering if thereis any specific drivers that you can point us to as to what is driving yourperformance and secondly may be you can bifurcate between the existing book andhow that’s been performing verses some of the new markets and products that youare rolling out?

Mark Bertolini

Justin, there really is no oneunderlying factor that’s contributing towards success in the commercial MBR. Weare predicting cost trend. We are managing our cost categories, we are able toput attractive benefit designs in place, and basically forecast appropriatelyand manage to it. All segments are hitting there target MBRs, all regions. Sothe news that you see is pretty reflective of the reality of the situation.

Justin Lake - UBS

Okay. Is there any mix changethat's going on that is doing better in may be in the individual products thatare lower MLR?

Joe Zubretsky

Yeah, but quarter-to-quarter oreven year-over-year there are mix effects but they are not significant. And youare right, individual products and Student Health and these types of productsgenerally have lower benefit design. So, there are some issues with mix but inthis quarter’s result there is no significant mix effect in the MBR

Justin Lake - UBS

Okay and just one quick questionon membership. Within that 650,000 members, I think it will be helpful if youcould just spike out maybe what the benefits you are imbedding into that numberR from the AARP relationship as well as the HRPA. And then, I think with inthat Medicare private fee for service contract you mentioned, I want to makesure that’s not a new win, right? That would just be a conversion from acurrent ASO account. So that wouldn’t be imbedded in the new membership number,correct?

Joe Zubretsky

That’s correct. In terms of 2008,I think you should look at it this way that significant membership increases inAARP would be upside to the 650 and HRPA as well. And yes the conversion of aself insured Medicare account to a full risk insured account will not increasemembership but will increase the revenue once we understand the openenrollment. That is why we are not giving guidance on the revenue take on thatconversion today.

Justin Lake - UBS

Got it, thanks.

Operator

We will go next to [Bill George]- JP Morgan

Bill George - J P Morgan

Thanks, good morning. Throughout’07 you have combined well above average membership growth with a very stablemedical loss ratio. And my question is, as you look out into ’08, forecastinganother year of above industry average membership growth. How confident are youof two specific metrics; first of all, your pricing and are you winningbusiness based on price. And then the flipside of the same coin is, howconfident are you on the cost side that you are capturing the true actuarialmovements in costs given such a rapid increase in volume?

Joe Zubretsky

Well I would start out by saying that we’ve a verydisciplined pricing strategy and we continue to focus on making certain that weare achieving profitable growth and in the context of the medical costs, wethink we have good information and good systems. That’s always in the contextof the inherit nature of completion factors and what you know about thebusiness, but I think we feel very good about where we are. I think I wouldalso suggest that the growth is widely diversified and in very identifiable anddefined pockets where we had actuaries, financial staff, underwriters and a teamof people focused on trying to be certain that we have properly aligned pricingand cost. So still the answer is, we feel very good about where we are and arecomfortable.

Bill George - J P Morgan

Okay. And just on the slight pressure from our Rx costs thatyou are seeing, is there an offset because you seem to be holding your costforecast within the same range?

Ron Williams

There's Mark responding that.

Mark Bertolini

Yeah Bill we are seeing the uptick year over year as aresult of the generic launches in 2007, particularly around simvastatin. So, weare seeing a release of that. That’s being baked into the baseline and now weare seeing the normal trend takeover again. So that’s the shift we see. However,because of our investments in mail order delivery where we have much a highergeneric penetration rate and in specialty pharmacy, where we were dealing witha lot of the pharmaceutical issues that are embedded in the medical benefit wesee that our pharmacy trend will be offset by other issues even within pharmacytrend overall and then across the rest of the medical cost spectrum.

Bill George - J P Morgan

Okay. And if I could, I had just one more quick one on TRICARE,can you update us in terms of the timing of that process?

Ron Williams

Well we are awaiting the TRICARE RFP to actually be issued. Wehad expected it few weeks ago. There is a new date. We will see if that date isactually achieved. Once we have the RFP in house, we would be in a position tothen analyze it and determine the degree to which we believe we can offer thegovernment a superior solutions, which we believe there is a potential for usto do. But we would wait to actually receive the RFP to understand the truerequest.

Bill George - J P Morgan

Okay. Can you share the date with us?

Ron Williams

Right now I believe it is November 15. But it was October9th last, so we we’ll see what happens. I am sure they have lots of thingsgoing on and they want to make certain that it is done right.

Bill George - J P Morgan

Great. Thank you

Operator

We will take our next question from MattPerry, Wachovia Capital Markets.

MattPerry - Wachovia Capital Markets

Hi good morning. Just wanted to clarify on the positiveprior period development in the Medicare business. First, can you give somedetails on specifically kind of what components of cost trend that related to?And then second I want to be clear and understanding that its sound like youdon’t expect that favorable development to lead to kind of better MCR goingforward? And why isn’t that the case?

Joe Zubretsky

Now this is Joe Zubretsky. I think there is a point Ron madejust a few minutes ago. We enter a new market with a new product. You know, wetake a very cautious and conservative view of the profitability of that productand what you are seeing is launched Private Fee-for-Service earlier in the year.We took a very cautious view on medical costs and now with three quarters ofvisibility, we need to release those reserves and get it back to its targetprofitability. And that’s really what you are seeing.

MattPerry - Wachovia Capital Markets

And anything specific you want to highlight on what thosecosts relate to?

Joe Zubretsky

No I think we priced it to a target. We probably accountedfor it, [and once that's] the target and now we are releasing it back to itspricing target.

MattPerry - Wachovia Capital Markets

Okay. And then just a second question on Medicare, what typeof yield on per member per month revenue should we be expecting for ’08?

Joe Zubretsky

I think on balance when you look at the Medicare productsyou know they range from $950 a month to a $1,000 a month and you shouldcontinue to use that rate.

MattPerry - Wachovia Capital Markets

Okay, thanks. That’s all I had.

Operator

We’ll go next to Christine Arnold, Morgan Stanley.

Christine Arnold -Morgan Stanley

Good morning. Question for me relates to your commercialMLR, commercial MLR is doing really, really well, but you are kind ofapproaching kind of the trough levels we saw entering 2006 when you guys havedecided kind of renewing small groups who were coming in at a higher MLRbecause of the competitive pressures and other things. Could you talk aboutwhat your business mix is right now how many individual, how many small group,how many large group, with respect to your Aetna'scommercial book? And is this the long-term sustainable MLR given that businessmix? Or will there be upward pressure over the next three to five years?

Joe Zubretsky

I think Christine, this is Joe. The business mix hasn’tchanged all that much. Yes, the individual product line Medicare is growingfaster than the core business, but as I said you know there has been nosignificant mix effect in the MBR reported this quarter. All products arehitting their target margins and we are very confident that you know some wherearound the 80% level for the MBR seems to be equilibrium in the marketplace.

Ron Williams

Christine, we look at by segment our new business MLRsversus our renewing business MLRs versus our departing business MLRs

Christine Arnold -Morgan Stanley

Okay

Ron Williams

And we see those as very stable and consistent with ourexpectations for next year. And again we are not competing on price in marketswhere we are growing, we are competing on our distribution channels and thetypes of products we are offering including our networks.

Christine Arnold -Morgan Stanley

Can you give us a sense for your business mix right now,individual, small group or large group or the commercial at-risk book?

Ron Williams

I don’t think we are prepared to give that delineation onour membership at this time, Christine.

Christine Arnold -Morgan Stanley

Okay thank you

Operator

We’ll go next to Charles Boorady, Citi

Charles Boorady -Citi

Thanks, good morning. My first question on commercial riskenrollment, you've talked about individuals as one of many growth drivers andone that you’ve had lot of success in it. I wonder what your individualenrollments and how that's grown over the past year or two?

Ron Williams

I would start directionally, Charles, when we started downthe process of focusing on this segment our enrollment was really minimal. Wereally did not have a capability that we had developed to serve this market.The enrollment was really the residual of what we had from states where you hadto issue to a individual product, and New York was one of those states, andthen we had a little bit of conversion business. So, I would say that as wehave rolled out across the country, based on building the capabilities and theunderwriting software and the tools and recruiting and developing the staff, wefeel very good about the growth prospects. As you know, there are approximately19 million people in the United Stateswho purchase their own individual health insurance and Aetnahad virtually none of that business. We have a great brand. We have many peoplewho are working now on one of my national accounts in there, graphic designerand they decide to leave and that their business have won and they would loveto buy an individual policy. And so our brand is really helping us a lot. Interms of the membership, I am going to ask Joe, I am now sure if we talkspecifically about it.

Joe Zubretsky

We haven't really talked specifically about it, but it's nota huge category for us. With over 16 million members, it’s less than 2% of themembership. So as it gets more meaningful we'll spike that out for you.

Charles Boorady -Citi

Great. And can you talk about your backlog of MedicareAdvantage opportunities with retirees, is that something that you are seeing apotential for in '08 or might it be more of an '09 or '10 opportunity inparticular with the HRPA relationship?

Ron Williams

Charles, you are referring to the sales pipeline, is thatthe…?

Charles Boorady -Citi

Yes.

Ron Williams

Okay. Mark?

Mark Bertolini

Yes, Charles, I will take sort of three different views foryou, in the government and labor sector we see a lot of interest around howgovernment is particularly organized or [bargained] governments handle their retiree liabilities going forward and topeg that retiree liability including how to fund some of them. Because there issome ramification of their own funded liabilities. And so, we have thatconversation going on. Those are longer lead times. Those generally take longerthen a year to convince, they ought to move, and some of them are just comingup to the speed on GASB as we speak. In HRPA we've had a lot of discussions aswe've launched the product. We've had a lot of bids that we put in front ofemployers who are working through those bids. Those are nearer term and weexpect that we will see continued opportunity in that pipeline as we go throughthe next 12 months to 18 months. And then in the individual business ourrelationship with AARP and our growing Medicare Advantage business that’s goingto largely depend on how the government reacts to Medicare Advantage and the verbalsupport in funding this, they provide for that.

Charles Boorady -Citi

Can you size any of those up-mark, the GASB opportunity in particular, what a rough ballparknumber is there? How many eligible lives?

Ron Williams

We haven’t given that number, I can tell you the unfunded GASBliability in the United States is approaching over $1.3 trillion.

Charles Boorady -Citi

Alright, thank you.

Operator

And there are no further questions. Mr. Chaffkin, I wouldlike to turn the call back over to you for any additional or closing remarks.

Jeff Chaffkin

Thank you. I just want all the people to know that a transcriptof the prepared portion of this call will be posted shortly on the InvestorInformation section of the Aetna website at aetna.com.If you have any questions about matters discussed this morning, please feelfree to call me or one of my colleagues in the Investor Relations office. Thankyou again for joining us this morning.

Operator

And this does conclude today's conference. Thank you for youparticipation.

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Source: Aetna Q3 2007 Earnings Call Transcript

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