UnitedHealth Group, Inc. Q4 2007 Earnings Call Transcripts

UnitedHealth Group, Inc. (UNH)

Q4 2007 Earnings Conference Call

January 22, 2008, 8:45 am ET

Executives

Stephen Hemsley - President and Chief Executive Officer

Mike Mikan - Chief Financial Officer

David Wichmann - Executive Vice President; President of Individual and Employer Markets Group

Ken Burdick - Chief Executive Officer of UnitedHealthcare Group

Mike Matteo - Chief Executive Officer of Uniprise

Rick Jelinek - Chief Executive Officer of AmeriChoice

Simon Stevens - Vice President

Analysts

Josh Raskin - Lehman Brothers

Bill Georges - J.P. Morgan

Charles Boorady - Citi

Justin Lake - UBS

Christine Arnold - Morgan Stanley

Greg Nersessian - Credit Suisse

Matthew Borsch - Goldman Sachs

Scott Fidel - Deutsche Bank

Sheryl Skolnick - CRT Capital Group

Carl McDonald - Oppenheimer

John Rex - Bear Stearns

Presentation

Operator

My name is Dennis, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the UnitedHealth Group Fourth Quarter and the year ended 2007 Earnings Conference Call. All lines have 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 call and these contents are the property of UnitedHealth Group. Any use, copying or distribution without written permission from UnitedHealth Group is strictly prohibited. Here is some important introductory information. This call will reference non-GAAP amounts. Reconciliation of non-GAAP to GAAP amounts is available on the financial reports and SEC section of the company's investor information page at www.unitedhealthgroup.com.

This call contains forward-looking statements under U.S. Federal Securities laws. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from historical experience and present expectations. A description of some of the risks and uncertainties can be found in reports that we filed with the Securities and Exchange Commission from time-to-time including the cautionary statements included in our annual reports on Form 10-K, and quarterly reports on Form 10-Q, as well as our current report on Form 8-K filed in connection with the company's January 22, 2008 earnings release.

Information presented on this call is contained in the earnings release and Form 8-K dated January 22, 2007 which may be accessed from the investor information page of the company's website at www.unitedhealthgroup.com. I would now like to turn the conference over to the President and Chief Executive Officer of UnitedHealth Group, Stephen Hemsley

Stephen Hemsley - President and Chief Executive Officer

Good morning and thank you for joining us this morning. In 2007, our primary goals were continued predictable growth in earnings, the strengthening of our operating fundamentals, and further leveraging the value of our diversified market-facing business approaches, including our capacity to generate and apply capital to build share holder value. As we look at UnitedHealth Group's 2007 performance, we can report that we have begun to make strong advances in all of these areas, and that we have a significantly more powerful sense of momentum than we had at this time last year.

Fourth quarter earnings of $0.92 per share bought full year 2007 earnings to an adjusted $3.50 per share. That represents an increase of 18% over full year 2006 results. Earnings growth was driven by a more than $1 billion increase in adjusted operating earnings, and complemented by a reduction of more than 40 million weighted average shares outstanding for the year. We saw improved profitability in public and senior program, while Enterprise Services businesses continued to deliver exceptional growth in financial performance. These strong performances were offset by year long softness in our commercial risk benefits business, which today represents roughly 40% of our operating earnings. However, our medical care ratio improved by 60 basis point year-over-year, and our operating profit margin expanded from 9.8% to 10.6% as adjusted.

The value of our diversified business approach was evident again in 2007, as we pursued expansion in virtually every segment of the Healthcare landscape. Our earnings stream continues to diversify by business, product, service line, client type and geography. Our operating performance continues to strengthen across the full expanse of our businesses, with a smooth transition into January for commercial, senior and public sector clients.

We continue to see clear improvements in our market relationships and in service, as measured both by our metrics and more importantly by direct market feedback. We are installing a greater emphasis enterprise wide and building relationship equity with all of our stakeholders, and those efforts are beginning to get traction.

Our [own] capital generation remains at distinctive characteristic of our organization. We reported cash flows from operations approaching $6 billion in 2007 or 126% of net income. We achieve these results amidst reductions in risk-based memberships at UnitedHealthcare, Ovations Medicare Advantage, which underscores both our remarkable cash production capacity our businesses have and the critical focus we maintain on capital generation.

I would note that there were some timing differences that impact fourth quarter cash flows, including certain state Medicaid receivables, some accelerated income tax items, and the timing of certain federal program payment. We now expect cash flows to be roughly $7 billion in 2008.

We increased our debt-to-total capital ratio in 2007 from 26% to 35%, and expanded our share repurchase commitment while maintaining strong credit ratings. We repurchased 125 million shares in 2007 for $6.6 billion, including 40 million shares for $2.2 billion in the fourth quarter. This fourth quarter activity gives us a strong start on our stated target $7 billion in share repurchase by year-end 2008.

In addition, we had $2.4 billion in cash on hand, as well as further debt capacity as of December 31. Our capital will support our previously announced all cash mergers, share repurchase goals and general corporate uses.

While 2007 was seen as a quite year for us on the merger and acquisition front, we made a number of significant moves to strengthen our enterprise. The most visible announced acquisitions were Sierra, Fiserv and in early 2008 Unison. We also executed a number of lower profile, but strategically important acquisitions, including the Lewin Group in public policy consulting, Administration Resources Corporation, the market leader in VEBA administration and Healthia, Lighthouse MD and Red Oak in clinical data and physician revenue cycle management.

Since we are discussing capital, I will anticipate a question about our investment portfolio. We have a total portfolio of cash and investments of about $22.3 billion. Our exposure at the beginning of the fourth quarter to sub prime loans was the de minimis, and what little exposure we did have was further reduced in the quarter.

Our municipal bond portfolio is about $5.5 billion in size and represents about one fourth of our total cash and investments. Those bonds were selected by highly regarded outside investment managers, specifically based on the strong underlying credit quality of the issuers, and independent of any credit insurance. Our investment philosophy remains one of conservatism, rather than one of overreaching for yield and that approach has produced dependable result in times of bond market turbulence in the past.

As we discussed at our recent Investor Day, we have completed the transition to our new business segment financial reporting this quarter. We have posted historical quarterly detail for 2006 and 2007 for both income statements and the membership payables on our website. And Mike Mikan can answer any questions you may have related to these changes through the course of the day.

We will now turn to a brief discussion of our key fourth quarter January trends in the areas costs, growth and client delivery. The short version is that all three of these are tracking with our most recent outlook. Full year adjusted earnings from operations of $8.025 billion were near the upper end of our range we provided at Investor Day.

Year-over-year earnings growth in enterprise service businesses continued to be powerful in the quarter. Healthcare services earnings showed an expected sequential decline, which reflected the decrease in earnings in the commercial benefits businesses due to normal seasonal usage patterns, as well as the increased investment in marketing to seniors.

In general, our businesses serving senior and public sector markets had another very solid quarter and showed strong year-over-year earnings improvement.

Fourth quarter medical cost trends were in line with expectations, with the full year medical care ratio of 80.6% in line with the low end of our Investor Day outlook.

Ovations and AmeriChoice again had strong gross profit results, continuing their recent trends. The commercial risk medical care ratio for UnitedHealthcare was 83.7% in the quarter, brining the full year ratio at 82.1%. That fourth quarter care ratio includes certain negative non-recurring items, the largest of which is an accrual that reduced premium revenues in the quarter due to one state recently issued regulatory determination on prior year underwriting performance.

After consideration of these our fourth quarter medical care ratio was above what we expected for the quarter. This includes the prudent and appropriate accrual for estimated medical costs in high deductible health policies, which incurs seasonally higher claims cost in the fourth quarter each year.

All in, our 2007 full year commercial medical cost trend came in comfortably within the 7% to 7.5% range we discussed at Investor Day. We are pleased with that excellent and consistent medical cost trend performance.

Fourth quarter operating costs remained well controlled, coming in at 14.4% in the quarter and bringing full year to 13.8% as adjusted. This sequential quarterly increase in operating costs of about $80 million included expenses for fully staffing the annual January surge and benefit changes in enrollment service needs for membership businesses and marketing costs for our senior business, including significant advertising and market launch expenditures for the only Medicare Advantage product branded with the AARP name.

Turning to January 2008 growth, we are still truing up retention figures, so these remark are very much based on preliminary estimates. Our enterprise services businesses are on track for solid 2008 revenue growth. Ingenix closed the year with a revenue backlog exceeding $1.7 billion, an increase of 46% over the last year.

OptumHealth's integrated capabilities at new branding are resonating well with customers in both the employer and payor markets. Exante, which is being re-branded as Optum Financial Services has been building its electronic payment network at a rapid pace and moved to total of $19 billion in funds electronically in 2007, an increase of 80%.

Prescription Solutions is in final negotiations for the location of its third mail service facility, and will start fitting out this base in early 2008. As we move aggressively do advance our growth agenda.

I would point out that this collection of enterprise services businesses made more operating profit in 2007 than the entirety of UnitedHealth Group did in 2000. They are each well situated for growth in 2008 and for longer-term performance.

AmeriChoice grew by 245,000 people in 2007, a 17% advance including 10,000 people in the fourth quarter. We are pleased with the momentum AmeriChoice has generated this past year, which includes the new Medicaid program in Tennessee, SCHIP in Texas and the January 1 launch of an innovative consumer-driven model serving the uninsured population in Indiana.

We anticipate continue growth during 2008 from this business. Additionally the state of Tennessee recently issued its RFP for the east and west regions, and we are well positioned to pursue both. Missouri and Connecticut are also markets we are evaluating for 2008 expansion.

Our pending acquisition of Unison will further strengthen AmeriChoice in these states and expand our services in this high growth market segment, sort of, to a total of more than 2 million people. We expect this transaction will close before the end of the second quarter.

In Medicare Advantage, our advance planning, broker training, national and local market advertising and electronic enrollment processes drove a productive start to the selling season. This is a much improved position from last year. The broker channel has reengaged and the build out of our internal distribution channels will continue throughout the year and into 2009.

Ovations is off to a strong start with preliminary January figures, putting us on pace for growth of 145,000 to 175,000 people, with Medicare Advantage offerings in 2008 as we set out at Investor Day. Compared with last year, new sales are meaningfully up and customer retention has improved sharply. Our strong growth sales are estimated to net out at around 60,000 to 85,000 new members by the end of the open-enrollment period, which runs through March 31.

We continue to expect that one-half of our annual growth in this line will come after April 1 from [8th June] activity and in particular strong monthly growth trends in our expanded chronic care special needs plan.

Those are all organic numbers and exclude any impact from the pending Sierra acquisition. While we are limited in what we can say here, we are in very advanced and productive discussions with the Department of Justice and planned to close this year transaction in the near future.

As per Part D, as previously discussed, January saw the reassignment by the government of the number of our Part D low income members. We anticipate a reduction of about 650,000 people that will be at least partially offset by open-market growth, the pending acquisition of Sierra's Part D business and the Part D component of the new Medicare Advantage enrollment activity I mentioned a moment ago.

In the Part D open-market, our sales trends are quite satisfactory, recognizing that of course we need to wait to shoot up this enrollment data from CMS before we have any final numbers.

As we discussed at our Commercial Day, or our Investor Day, our commercial market businesses, UnitedHealthcare and Uniprise remain soft. The first quarter 2008 decline in people serve through fee-based arrangements is trending closer to 150,000 than to 200,000 people as we are performing better than expected in open-enrollment results with large employers. We believe this is an early reflection in our service gains, which I will discuss in a minute.

First quarter losses in risk-based commercial products appear closer to 400,000 people than 350,000. The components of the 400,000 include more than 200,000 from the PacifiCare, 75,000 on funding conversions that remained with our company and the balance representing organic decline.

We are still truing up all of these numbers, but it appears that first quarter will still have the expected decline of about 2% in total. Our results in 2008 business will be strengthened by the acquisition of Fiserv, adding close to 2 million consumers serve through fee-based arrangement and Sierra contributing additional risk-based consumers in commercial market businesses. This would result in a net gain of 7% in the first quarter for the UnitedHealthcare and Uniprise commercial benefit markets.

Let me now address our pricing discipline and improving service performance, which are critical given their effort, the effects on organic growth layer in 2008 and into 2009. We continue to match UnitedHealthcare pricing to medical cost trends and expect to maintain a stable full year medical care ratio at around 82% plus or minus 50 basis points.

With natural quarterly utilization fluctuations, our fourth quarter 2007 revenues show a sequential improvement in the rate of increase in realized per member per month yield, and we expect this trend will continue steadily in 2008. We remained comfortable with and committed to our discipline in long-term philosophy of pricing to our medical cost trends.

As you are aware, we started it early last year on a conservative effort to rebuild and enhance our service, which had impacted UnitedHealthcare's growth, with both fee-based and risk-based customers. At Investor Day, Dave Wichmann discussed in detail the significant commitment to this area and the tangible results we have already achieved.

In summary, we focused leadership and resources on the issue and our service levels have recovered strongly. We have more to do with Legacy PacifiCare, but we are otherwise back to market performance levels and will further improve our service metrics throughout the rest of this year. We are pleased to report to you continuing advances in these areas.

Let's start with some basics. Intense focus has brought down our adjusted inventories by 80% over the past six months, and turnaround time on issues improved by more than 40% from the third quarter to the fourth quarter of 2007. We expect to perform to less than 48 hour inventory on issue resolution going forward and we anticipate that this increased fee, the resolution will be felt positively by clients and physicians alike.

Our quality also continues to improve. With first call accuracy in the fourth quarter up 20% year-over-year for consumers and 60% year-over-year for physicians. Our emerging service approach integrates pharmaceutical, medical and administrative data enabling empowered experts to provide once and done resolution service across these key functional area. The feedback on this approach has been powerfully positive and we are expanding aspects of it broadly to the marketplace.

Our dollar accuracy on claims payment has advanced 80 basis points in the past year to over 99% in the fourth quarter. We are seeing improved audit scores from consultants that will continue to improve in 2008, as fresher results begin to recover by their reviews.

With regard to access, an independent third-party survey found more U.S. physician offices except UnitedHealthcare than any other insurance claim. We added more than 40,000 physicians and other care providers to our network in 2007, and continue to advance consumer access with key hospitals, most recently Advocate in Chicago.

I would point out that less than 50 basis points of our hospital spend was in out of network status at any time, even for one day in 2007, taken for a highly stable network.

Our Premium designation program is critical to consumers who want to make in-form decisions about the quality and cost of their care into our new generation of consumer products such as Edge. In 2008, the Premium designation network encompassed 21 distinct medical specialties and is available to consumers in 38 states, plus the District of Columbia. This is an important component of our integrated strategy to support consumers in receiving the right care at a right time and place. Sophisticated employers understand the value of an Advocate for this kind of transparency for their employees and their families.

In our customer satisfaction on post call surveys continues to be in the 98% of our range in the fourth quarter and nearly 98% in December using the strengthened service approach as described earlier. Consumer surveyed immediately after their interaction with our agents are indicating strong improvements in overall satisfaction. Also important to note, that 2007 was another fertile year for innovation across UnitedHealth Group. We introduced exciting new products such as Edge and Vital Measures. We expanded the integration of comprehensive Care Advocacy protocols. Launched the next generation of consumer products, advanced and began to scale the integration of financial services, expanded our real time adjudication capability, introduced the personal pharmacy history, brought premium designation program to scale and became the first company to adopt NCCN standards for determining chemotherapy drug coverage as part of our commitments to [best science]. And as I mentioned; launched an innovative service model that is delivering compelling results for our customers.

We are gratified to have been named most innovative company in our industry in the most recent fortune survey. These service and innovation examples all directly relate to the broader aspiration of performing as an integrated UnitedHealth Group Systems. We look forward both to external market validation of these gains and continued advancement and innovation in 2008.

I will close with a brief summary and some forward-looking comments. This year and quarter, we have done what we told you we would do. We refocused to improve fundamental execution and we will maintain that focus. We continue to expand and enrich our network across all products and did so with significantly lower levels of disruption. We have substantially addressed PacifiCare integration and broader service issues, and fully recognize that we must continue to strengthen that market quarter-by-quarter throughout 2008.

We executed on our marketing and sales approach in the Medicare Advantage and Part D sales season. We strengthened our discipline in pricing to cost across the commercial benefit market even at the cost of membership growth and demonstrated it with improving yield in the quarter.

At 2007 adjusted earning per share increased by 18%. This is directly the result of diversified, adaptable, and market-focused businesses. We are positioned to deliver continuous strong results in 2008, and key elements for 2008 include an accelerating Medicare Advantage business supported by an exclusive alliance with AARP for 2014, expanded product offerings and expanded geographic footprints and great brand name recognition. Second; market place recognition of our stronger service performance across the board.

New product launches and an intense focus on profitable growth in our commercial market, a continued commitment to pricing discipline, timely closure of the Sierra and Unison mergers and as always our ongoing commitment to effective capital management. We continue to project revenues to be around $83 billion. The impact of the timing of the Sierra acquisition kind of a potential resolution with the Justice Department will be more than offset by closure of Fiserv. Unison represents potential upside of revenue. We expect earnings of $3.95 to $4 per share in 2008 supported by cash flow of $7 billion, and we are targeting first quarter earnings in a range of $0.82 to $0.84 per share or 11% to 14% over the prior year as adjusted.

As we pointed out in Investor Day, we are focused on the greater, long-term opportunity to become a truly unique enterprise. The opportunity to build out UnitedHealth Group as an open and engaged health system, one that could adapt to ever changing market conditions and shifting demand in the dynamic healthcare landscape.

I want to thank our employees for their focus and support from our customers and our businesses during 2007. We stand together dedicated de-leveraging our ideas, unique capabilities in scale, our solid execution and our strong financial standing for the benefit of the entire healthcare community, our customers, our employees and our investors.

We appreciate your interest today and we can now move to questions, I'm joined in this room by many of our senior business colleagues. And John Penshorn, Brett Manderfeld, and Mike Mikan and others will continue to be available after this call to respond to any additional questions you may have. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question will come from the line of Josh Raskin with Lehman Brothers.

Josh Raskin

Hi, thanks good morning. Question on the improvement in the service metrics, I think you guys have a lot of statistics to sort of back it up, in terms of the internal measurement, but I'm curious how do you measure the external constituents? I mean are there broker surveys that you do or how do you get sort of comfort that the market's recognizing that or it's just simply looking at your membership growth?

Stephen Hemsley

Well Josh, I would react on two levels. Obviously given our focus on this we have been in a very consistent contact with brokers, with consultants, with employers and soliciting very direct feedback in terms for our performance in these areas. And I cannot overstate the degree of connection we have been pursuing and will continue to pursue with that. And that is one channel of direct feedback.

I would point to another, and that is our post call, post contact surveys with consumers directly and with physicians with respect to their satisfaction and our follow-up in terms of any areas where they express concerns. And we monitor those surveys, which are really available and done on every call, at every contact, so that we can really track trends in this area. And those have been trending so strongly, favorable through the course of the year that is I think another very credible and fact-based respond with respect to our service levels. But I would also -- we have [Dirk McMann] here and Dave Wichmann and I think perhaps they can respond more effectively.

Dirk McMann

So, what I would also say is that, Josh, after the call is over, we'd both take a survey and if there is a negative result on that survey, what happens is that the negative result is defined as two standard deviations from the mean in terms of performance, and that email immediately goes to one of our supervisors and the supervisor follows up within 24 hours with that particular customer to make sure the issue is exactly resolved. As a result of it we have also been very, very powerful on a very first call, first contact basis. And that’s where we look the trend that we are seeing, and that just being followed up.

David Wichmann

From a call perspective in terms of how we have improved, we have moved from about a 4% plus error rate at the beginning of last year to a 2% error rate at the end of this year.

Josh Raskin

I think what I am trying to bridge is, is these improvements in these metrics which is obvious, I mean the level of service is obviously dramatically better. I guess I am trying to bridge that with the expectations around membership. I think, you've alluded to the commercial businesses, first quarter loss is trending a little bit better than expected. Is it fair to say that's where the outlook for the full year. I think you had said last time that you would had growth in the sequential quarters two, three and fourth, is there -- maybe an update as to what you expect full year membership to look like?

David Wichmann

Yeah, I'll let Ken Burdick and Mike Matteo respond to that, but our view in terms of membership guidance is really unchanged. We do expect to see positive growth, particularly in the risk products in the third and fourth quarters. And I would say to your opening comment that the momentum is, dynamics are clearly distinctively different than they were at that time last year. Ken?

Ken Burdick

Good morning, Josh. Let me just respond on the outlook for the remainder of the year. You are correct. We continue to have an expectation that is absolutely in line with the guidance from the Investor Day. There has been some variation in January results by funding type, but the outlook for the remainder of the year is for growth both in the fully insured space as well as the fee-based business and is really attributable to several things.

Number one, the improvements that the marketplace is seeing in both service and in the network stability. Number two, the impact of the new generation of the broader range price point products that we discussed at some length at Investor Day. And then third, we're really starting to get traction from the focus on expanding and revitalizing our broker and consultant's distribution channel.

And maybe I'll let Mike Matteo speak to some of the success we've had with some of the open enrollments.

Mike Matteo

Thanks Ken. In terms of our large case market with Uniprise, we saw a better first quarter than anticipated and a lot of that is attributable to working in concert with our large employers and then partnership really helping them to showcase what we can do from a service perspective but a medical cost trend perspective and our ability to attract and retain individual members when they have a choice between us and the competing plan, and so open enrollment results were actually better than expected this year for January in the first quarter.

Josh Raskin

Okay, thanks.

Stephen Hemsley

I'll throw one point of clarification in and that is, as we've said, we are down 50,000 more than we anticipated as we look at January. We don't see recovering that 50,000 but the expectation that we have in terms of growth for the balance of the year and that mix continues to be in line with our Investor guidance. Bill, next question please.

Operator

Our next question will come from the line of Bill Georges with J.P. Morgan.

Bill Georges

Thanks, good morning. I'm wondering, if you could just help out with a little more detail around your commercial medical loss ratio and I guess, you mentioned during the prepared remarks, some sort of state funding requirement, I wasn't exactly clear on what that was but could you, if possible, strike out the moving parts around the higher commercial MLR?

Ken Burdick

I would ask Mike here to respond?

Mike Matteo

Bill, I don't want to get into the specifics on the regulatory item, because it's an ongoing negotiation. But I'll try to breakout and give you a little more detail on the context into what Steve said earlier. We did book the fourth quarter to an 83.7% medical care ratio. That was impacted by the special cause items that Steve had mentioned. The regulatory item was something we were made aware of in the late second quarter, early third quarter. At that time we booked to our best estimate based on our interpretation of the statute and legal advice. We worked with this individual state throughout the remainder of the year. Based on new information we have reconciled this best estimate with the state, and that impacted our fourth quarter tier ratio. If you excluded those items, we would be in line with the expectation that we gave at the end of the third quarter.

Bill Georges

Okay. And if you could also just provide detail on the moving parts in your cost trend forecast for '08?

Mike Matteo

On that I wouldn't stick with what we had at the Investor Day conference that I laid out for you and I think also Ken Burdick did as well.

Bill Georges

Okay. So no change in view of the component and cost trends?

Mike Matteo

No we would still be overall at 7.5% plus or minus 50 basis points for 2008.

Bill Georges

Okay, great. Thanks very much.

Stephen Hemsley

Next question please?

Operator

Your next question will come from the line of Charles Boorady with Citi.

Charles Boorady

Hi thanks good morning. Just curious in light of the changing economic environment what assumptions you are making about the impact of the economy in '08 versus '07 in terms of the top line from the potential for lay-offs and pressure on state budgets in your state programs? And then on the medical expense line, one could argue for lower trends if you assume that we consumers are going to consume less healthcare but there is also some evidence that people accelerate consumption ahead of being laid off in healthcare, I'm not sure how you see those two offsetting each other?

Stephen Hemsley

While there are several dimensions to that one question, we build assumptions for attrition into our outlook and I'll have Dave Wichmann respond to that, I'll also suggest that the cost pressures that are imposed on states often present opportunities, probably more often than not present opportunities for us in growth, so we often view those pressures at the positive in terms of the growth outlook. And then I'll have Mike kind of respond to the economic impact that might manifest itself on trends, so Dave.

David Wichmann

Good morning, Charles. As you'd have expect we too are concerned about employment levels and the fact that they may drop off, we believe that we accounted for nominal costs attrition in our forecasts, however depending upon the severity of the economic conditions that of course could be more severe as well. To-date we have seen some modest, very modest declines in the financial services industry, related to the sub-prime in particular, beyond that we have really focused on advancing service and seeing if there is opportunities for us, so we can grow our enrollment within our existing clients. And I think as Mike Matteo pointed earlier in this response, we’ve been very successful with that large case marketplace, and believe that success is reflective about that improved service performance.

Stephen Hemsley

Rick, you want to talk about state progress

Rick Jelinek

On the state side, we have good visibility, and too -- roughly half of our markets are ready in terms of the rate settings for 2008 and we feel good about that in this year. In addition, as Steve mentioned any budget shortfalls or budget pressures at the state level provide opportunity for the business to grow in general, as more people are added on to the Medicaid rolls and the SCHIP rolls for the program. So, we feel very good about the prospects this year looking forward.

Stephen Hemsley

Charles, let me speak about utilization more in the broad context and then I will try to narrow in on the impact of the economy. And broadly speaking, we think our products align well to the individual's consumption behavior, that is, getting the individual more involved in the health care decision making process and that in fact has had a benefit on bringing utilization to a more appropriate level. We are also very intent on managing our costs. As you know, we've talked about significant healthcare affordability initiatives, driving bed-days, in-patient stays down and we have seen that again this year with another 1% or so decline in bed-day utilization.

With respect to the economy, as you know, healthcare consumption generally lags the economy, so at a point in time, when you are going into a recession, you generally are experiencing higher utilization that is already baked into our run rate, but we will continue to manage costs and utilization by aligning our products and all the things that we do around educating the consumer and managing utilization, broadly speaking to make sure that our cost trends are in line, if not industry leading and we feel very confident of that.

Charles Boorady

Have the employers been proactive in asking you to do more to control medical expenses, I saw your initiative on oncology and also mimicking Medicare on not paying for certain areas in the hospital? But are there other such initiatives that could bring down the trend?

Stephen Hemsley

Mike, do you want to speak, broadly speaking, from our customers' perspective?

Mike Mikan

Yeah. I would say, overall, from the large case perspective, customers are always interested in the affordability agenda. But this actually presents an opportunity where some customers who may have been, I would say, more paternalistic or willing to look at more aggressive tactics that help them manage costs, in terms of how they interact with the system, particularly around consumer driven health plans and really evaluating those and how that can part of their portfolio, to drive more aggressive cost trends. So, this economic exposure does at times create some opportunity for us to leverage what we have in our best-in-class network or premium networks and activation strategies with consumer driven health plans. So, that kind of opens up the conversation a little bit more.

Josh Raskin

Thank you.

Stephen Hemsley

Next question please?

Operator

Our next question will come from the line of Justin Lake with UBS.

Justin Lake

Thanks, good morning. Couple of questions, just first in regards to your -- obviously with the fourth quarter issues you had last year, I was just wondering if there is anything that you could tell us as far as what you've done to improve your visibility on cost trends or utilization, as you went into year-end and maybe compare that to last year. And same thing on the pricing side, you said, as you went through the first quarter of '08, it was apparent that your yield didn’t reach the levels that you were hoping for. Is there anything you could tell us as far as giving us an update in regards to what you see your pricing yields doing? And what you've done differently to see those trends?

Stephen Hemsley

Yeah. Ken do you want to respond to yield aspect of it?

Ken Burdick

All right. Thanks Justin. After seeing the fourth quarter results in '06, we began making adjustments in '07 to our pricing. Some of that fell towards the end of '07, much of that is going be felt in '08 and we are very confident that our pricing and our yield is tracking with our net-of-cost projections.

Justin Lake

Okay. Anything on the utilization side that you could tell us as far as what you saw at the -- maybe you had folks in the hospitals at the end of the year? Do you see anything differently than last year?

Stephen Hemsley

Mike.

Mike Mikan

Yeah. This is an area that we've spend -- as you can imagine Justin a fair amount of time on this year. Trying to get better information, real-time notification information from our hospitals, also understanding what is occurring in the outpatient setting, and then as important to that is just looking at the pharmacy data as we closed out the year between the holidays and we saw a significant drop-off in the pharmacy consumption which really last year occurred from two fold, one was the significant ramp up that we saw within, call it the high deductible benefit, just the switchover from traditional products into that. And then also, consumers that wanted to give their prescriptions filled and a outpatient procedure done near the end of the year, we just didn't anticipate that as you know last year we talked about that or at least the degree and this year we feel we are lot closer to understanding that and we feel we've reserved appropriately as you can see as indicated in our expected loss ratio for the fourth quarter.

Justin Lake

Great. And just one quick follow-up on the economic questions that Josh had, I saw that your accounts receivables was up about $200 million and your DSOs were up a day, I am just wondering if that's timing related or maybe there are some issues and I am just curious around the individual segment with the economy being what it is, I am wondering if you are seeing people maybe paying their bills a little bit later or not paying them at all as far as they are individual, maybe they are very small, and the small group on the premiums.

Mike Mikan

No, they were timing related issues and in particular Steve mentioned the state Medicaid payments, we had two states that we did not collect at the end of the year and we've collected in January already, so they are just timing differences.

Justin Lake

So, nothing on the individual side to worry about?

Mike Mikan

No nothing.

Stephen Hemsley

No actually they are receivables on the commercial businesses that had performed exceptionally well, most of the receivable growth as in the other businesses.

Justin Lake

Perfect, thank you.

Operator

Your next question will come from the line of Christine Arnold with Morgan Stanley.

Christine Arnold

Good morning. I have a question on your commercial MLR, the premium yield improved in the fourth quarter as you mentioned, you increased price such that you said much of the benefit will be felt kind of in the first quarter and into 2008. Given that the MLR was higher than your expectations in this business in '07, and you've taken pricing action, what's the potential that the MLR could improve in 2008? I know you are guiding for kind of stabilish plus or minus 50. But it seems to me it should improve given the pricing action, could you talk about that?

Stephen Hemsley

Well, we offered guidance that represented a corridor and obviously we are striving for stability there. I think there is potential for upside performance. But I think it would be very, very premature to provide any indications of it at this point in time. And so we are, our guidance stays where it is, but we would be looking to outperform it just as a natural instinct.

Christine Arnold

Okay. And then the follow-up. We've heard from the marketplace that you've changed some of the ASO terms entering 2008, in some cases in order to retain accounts, where there were some service issues. Can you talk about the change in ASO terms and how at risk you are for medical trends?

Stephen Hemsley

Yeah, I think my Mike Mikan is perhaps the best to respond to that and then maybe Dave Wichmann could put some color on it.

Mike Mikan

Yeah, thanks. When we look at the large case marketplace and the performance guarantees, we had to increase several amounts at risk from a service perspective, but we're that confident that that it will be a non issue for us going into the year. We do not have a very different profile in terms of a ASO fee at risk from an affordability perspective or a cost perspective in terms of that, while we've done it on selected accounts. It is not something we think will substantially change our risk profile in 2008 or 2009.

Christine Arnold

Is that because you don't think medical trends will hit that next quarter or because you didn't put much risk?

Mike Mikan

It's a little bit of combination of both while we've had to put some amounts at risk. We only will put at risk what we think we can hit and achieve. The other part of this is that in a large case market, we are able to achieve very good trends for our large customers even below some of those trends on our fully insured books of business.

Christine Arnold

Okay. Thank you.

Stephen Hemsley

Christine, the only thing I would add to that is that we throughout the year and just trying to get back to Josh's question, we throughout the year had seen a steady decline in the amount of payouts and performance guarantees our business particularly related to service. So it's just another external validation point.

Christine Arnold

Thank you.

Operator

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

Greg Nersessian

Hey, good morning. Thank you. My question is just on the quarterly progression of earnings next year and just specifically in light of three factors, I just wanted to hopefully get a better understanding for the first is just a loss of the dual-eligible PDP lives. How that might influence the earning seasonality innovations?

The second was just on the NA marketing cost related to the AARP relationship in '08. Was there any one-time amount of spending this year, or would you expect the same amount of spending next-gen?

And the final piece is just on the high-deductible plans in the commercial book. Has that kind of stabilized, or would you expect to commercial MLR progression to get even more pronounce? Thank you.

Stephen Hemsley

I think I have Mike respond in terms of those elements and then from our business point of view, we might add some color.

Greg Nersessian

Okay.

Mike Mikan

Okay. With respect to the loss, there is two things going on with the Part D. One, as you know, the change in the risk corridor, which will affect the quarters, especially the first three quarters negatively and then positively in the fourth quarter. That will be somewhat offset by favorable impact of not having the level of Part D dual-eligibles in the first quarter, so that should be favorable in the first quarter offsetting some of that negativity. And then I apologize, what were the last two?

Stephen Hemsley

Actually high-deductible plans and I think that basically we have a very clear beat on that as the patents establish that would be roughly the same as, we expect it would be roughly the same as this year. And then with respect to marketing cost, there is no [on card]. I think Simon might respond to that.

Simon Stevens

Sure. Yes, Greg. So as far as the AARP brand launch is concerned, we have had a number of one-time launch costs, which we incurred in the second half of last year, which we wouldn't into this repeating at that same level next year.

Greg Nersessian

Could you quantify the magnitude of that or a range?

Mike Mikan

Well, we will obviously make adjustments as to precisely what the shape of that marketing spend would be next year, when we see the full year impact of it this year. But we have talked about the 30 basis points of costs associated with that in the last part of 2007.

Greg Nersessian

Okay. But just in, so just generally speaking, overall, the quarterly earnings progression for next year will be most impacted by the two Part D components Mike that you mentioned on the dual-eligibles and the risk corridors?

Mike Mikan

Yes.

Greg Nersessian

Okay. Thank you.

Operator

Your next question will come from the line of Matthew Borsch with Goldman Sachs.

Matthew Borsch

Yes, hi, good morning. Just a quick one on pricing. Could you characterize what you are seeing in the market versus maybe a year or two years ago, and particularly in terms of the intensity of price competition on the commercial risk side of the business?

And is there any variation between public companies and not for profits where maybe ones more aggressive, ones less aggressive than what you saw a year or two ago? And just, if I could just add to that one other piece which is, can you give us any sense of where you think the commercial risk MCR will land in the first quarter just because there is obviously a lot of focus on that metric.

Stephen Hemsley

So Ken, may be you should respond in terms of what you think the pricing environment is, and then Mike can talk to the first quarter care ratios.

Ken Burdick

Thank you, Mathew. Let me speak first for the, and [also] profits. We are seeing the consistent pricing behavior that we've really observed for the last 18 months to 24 months. No change. It continues to be competitive.

With respect to the individual market, that's where we think we have seen an increase in the number of competitors, which is driving a higher level of price competition. And then in the upper range, it's really consistent with the patterns that have emerged over the last couple of years. We don't see any fundamental change in the dynamics around either fee or risk-based pricing. It continues to be a competitive, but the rational market.

Stephen Hemsley

And relatively stable consistent with last 24 months.

Matthew Borsch

Great.

Stephen Hemsley

And ratio?

Mike Mikan

Hey Matt, when you adjust out -- as you know, last year we reported Q1 loss ratio in the UnitedHealthcare business of 81.2%. When you adjust out development, we believe that this year we will be in line with that adjusted loss ratio of around 80.5%, thus we would expect in the first quarter.

Matthew Borsch

Okay. Thank you.

Operator

Your next question will come from the line of Scott Fidel with Deutsche Bank.

Scott Fidel

Thanks. Good morning. Just had a question, just around if you could give us a little more details on the MA open-enrollment fees and then just relative to the net sales you are seeing, maybe how that's tracking in network-based products with the ARP relationship compared to private fee, and then also if you are seeing any higher dis-enrollments in terms of retention in MA, a couple of competitors have cited seeing some of that recently.

Stephen Hemsley

Simon, I think this is yours.

Simon Stevens

So, SecureHorizons folks are fairly seeing a sales turnaround from their position than last year, gross sales are up and determinations are down. As Steve said based on current enrollment trends, SecureHorizons believes that they should be on track for 60,000 or more, [next to] Medicare Advantage numbers sold by March 31 and effective by April 1, inline with our full year projection that we set out at Investor Day of a 125,000 to 175,000. As for product mix, we are seeing gross sales consistent with the strategy that we set out for you at Investor Day with deliberately strong acquisition in our network based products, AARP branded HMO products and [SNP] products together with private free-for-service sales, but focused particularly on our network-based offering.

Scott Fidel

And then in terms of dis-enrollments or retention levels, I think you said that there was tracking in line with expectations for '08 so far?

Simon Stevens

Yeah, I mean, our termination rates are significantly down on what they were last year. Well of course we have larger installed-base of Medicare Advantage members than anyone else in the industry, nearly 1.4 million members. So even with the much reduced termination rate, simply math means that we still have higher number of member exit during selling seasons than others, which we have to do then, let off against strong gross sales.

Scott Fidel

And if I can just ask a follow-up, just around the group Medicare piece and whether you've signed any sales to-date yet or/and then what the pipeline looks for the remainder of 2008 and then looking out to 2009?

Stephen Hemsley

Yeah, we are leader in the employer group retiree market place, we've got over 400,000 group Medicare members including those in Medicare Advantage. We are going to actively participate in the 2008 opportunities group business, recognizing of course for the large group as these are most likely to take effect for 1/1/'09. So I guess in parting it's worth remembering that much of the group medical advantage now showing up on the 1/1 Medicare roster actually reflect commercial life with other plans converted to Medicare advantage as far back as last summer.

Scott Fidel

Okay. Thank you.

Operator

Your next question will come from the line of Sheryl Skolnick with CRT Capital Group.

Sheryl Skolnick

Thank you very much. I'm a bit -- I'm very curious to understand what's happening with that one particular state, but I'll hope that we get some more clarity perhaps in the 10-K on that disclosure. So I don't want to waste my question by pressuring you on that point. But I guess where I do want to pressure you a little bit for more clarity or color if I could is, you mentioned the commercial membership was going to be down about 50,000 more than anticipated, and if I heard you, or at the lower end of the range. And if I heard you correctly Steve, you said that you probably don't make that up. A; is that correct? and B, did I hear you correctly, and D; can you break that down into; are these old products, are these markets in which you've not yet got any traction on your service and innovative product initiative or is that a lack of traction in the new, more innovative products or where you've put the effort into reconfiguring the broker channel?

Stephen Hemsley

First of all, Sheryl you absolutely heard correctly we are 50,000 and more and we are talking risk base.

Sheryl Skolnick

Right. That's what I mean, the commercial risk base.

Stephen Hemsley

Right.

Sheryl Skolnick

And if you are in a group size, can you give me more detail on where the weakness appears to be?

Stephen Hemsley

Ken you want to respond to that?

Ken Burdick

Sheryl, you are correct, that in the older product line as I mentioned in the Investor Day conference, our Edge product for example is rolling out throughout the country, but we only had it in 21 markets as of January. I'll just speak to the-- that the momentum that we are gaining, I'll sight one example of the Chicago market, because I know if I talk about things like network stability, and improved service, and broker engagement it may not resonate. I'll just quickly describe that using Chicago in example all of these things have come together, so that with the signing of Advocate we experienced growth in our small book for the first time in several years. We sold seven new customers with brokerage that we had not been writing business with. And we had 2500 additional members in one open-in-moment opportunity and our large case proposal activity is up 25%. And that's really -- its one illustration of the impact of this three of four different things that we talk about, as fundamental initiatives that are building momentum in our business.

Sheryl Skolnick

Okay. But never the less that was not enough to offset what appears to be another attrition story, and I’m trying to understand that, I mean we know about the American Medical Security attrition and the PHS book attrition, are we now going to have to go through another period in which new products replace old, new services replace old, and we have more than expected attrition, I mean I think that I know the attrition itself is obvious, but it sounds like its more than anticipated and that's what I’m trying to get at. Are we going into yet another cycle of disappointment because we're surprised by a lack of traction in the old product base for UnitedHealthcare.

Stephen Hemsley

No, Sheryl I would not think that that theme resonates, if you really take a look at the concentration, it is more California, I won't put it all in terms of PacifiCare, and I won't put it all in terms of repositioning of that book, but I would say, if there is a concentration, it is more in the California direction. And, I actually think that our outlook with respect to going forward is as I said more positive than we have been probably in a couple years. And, but now you are focused on risk, but we are also seeing fee performance, fee based product performance that was actually stronger in January than we anticipated and we are kind of positive with respect to that going forward as well.

Sheryl Skolnick

And the tax rate was lower than anticipated in the quarter, was there any specific reason for that?

Stephen Hemsley

That is right, Mike, you want to comment?

Mike Mikan

Yes we just -- when we did our end of the year reconciliation with the income across the different tax jurisdictions we had a favorable state income tax impact.

Sheryl Skolnick

I guess I am concerned, because the cash flow was lower, the tax rate was lower, there were couple of one time items in the quarter, the revenue was lighter, I know that's history, I know you want to look forward, but the quality of earnings there make me a little concerned. Why shouldn’t I be?

Mike Mikan

I actually think the quality of earnings is quite strong, I think we were very appropriate with respect to how we established care ratio for the fourth quarter. I think the earnings actually were at the upper end of our range. If you take a look at our earnings in terms of where we position them from an operating point of view at $8.25 billion, we were five short of the absolute upper end of the range. I think if you take a look at cash flow capacity that was approaching $6 billion and the cash is really more a function of timing, so we've basically strengthened the 2008. So, actually I don't see a quality issue at all, I actually see us addressing very appropriately any and all concerns that ends and continuing to perform well.

Sheryl Skolnick

Okay, thanks so much.

Mike Mikan

Thank you.

Operator

Our next question will come from the line of Carl McDonald with Oppenheimer.

Carl McDonald

Thanks, it looks like the Medicare Advantage had another very, very strong quarter in the fourth quarter. I am still having a little trouble cross-walking between the loss ratio in '07 to the expectation that the loss ratio is going to be stable again in 2008.

So, can you help us there in terms of, it looks like there was a lot of favorable development in the Medicare business in '07? Your assumption is that it doesn't continue in '08. Is there less favorable development impacting the Medicare business than we think there is or are there other factors that are helping 2008 and then offsetting the loss of that favorable development next year?

Stephen Hemsley

We'll let Mike start and then maybe Simon can add to it.

Mike Mikan

We talked about this after the first quarter. We've got a broad diverse business across the insured different block and development is, most of you all are aware that we did have negative prior period development or prior year development for the UnitedHealthcare business. We have a diverse block of business across Medicaid programs, the OptumHealth program, stop-loss and other. So, I don't want to just focus in on MA, which is what seems to be where we are naturally going. You do need to look at it across a block of business that represents and I know that's insurance cost, but that is, in fact, this part of the business is roughly call it $55 billion plus in medical cost and over $8 billion of medical payable. So, we need to make sure we are looking in the context of the overall block of business in that insurance stock?

Stephen Hemsley

Simon?

Simon Stevens

And then Carl just to supplement that in terms of the Medicare Advantage MCLs for 2008, you asked that there were other factors that might explain outlook and I would draw your attention to quite a few. The first is obviously the 2008 rates were reasonable. The second was that our 2008 benefits were designed prudently. Th1ird was medical cost trends are expected to be broadly stable. In addition our clinical model is gaining traction. The efficiency of the drug components of our services continues to improve and opt through a greater mail and generic usage. There are some annualized effects from the change in member mix that we sold during 2007, and of course the risk adjusted compensation that we now received to meet the health needs of our members this continuing the results flow [not a] one-time payment. So those are some of the variables that needed through the outlook that we have given you.

Carl McDonald

Do you want to quantify the impact on margins from field development to the Medicare Advantage business in '07?

Simon Stevens

We really haven't commented about that in any areas of our business. Should we get to the next question please?

Operator

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

John Rex

Thanks. I just wanted to go back to the commercial cost of accrual again here. Just thinking about, we saw this 4Q versus 4Q '06, if we adjusted the 4Q '06 for the negative development you talked about in the 1Q '07, if we roughly need you 16 [81.7] loss ratio compared to 83 call a plus a little bit this Q. And can you just help me understand like how much of this is about higher portion of your member shifting in high-deductible plans this year versus last of the 10 million UHG risk book. How much is -- you've alluded a couple of times to more conservative accruals in the commercial book as you exited 4Q. And can you just kind of give us a feel for what was driving that higher adjusted comp?

Stephen Hemsley

Well, John…

John Rex

Making it a pretty big shift.

Stephen Hemsley

It's a pretty big shift and it's getting in the detail and I don't want to get into reconciling non-GAAP items, so I will try to answer it as best as I can. And if I don't, I'll have John, Brett and I'll follow up with you afterwards. But to make sure we are getting to that question like I said as best we can.

If you go back to last year, the adjustments that -- the things that were impacting that loss ratio vis-à-vis the loss ratio this year and the fourth quarter are development the in and the out in both periods and that would be about call it a 150 basis points. So you were close to what I would have estimated the adjusted loss ratio to be.

We are impacted by those special costs items that we mentioned earlier. As you know even though we are seeing pricing increase, the impact on that has not -- on the loss ratio is not far enough along to see that result in the fourth quarter. We do expect our pricing actions to be seen in 2008, but that did impact as well.

And then also the net item that you are probably trying to quantify is the fourth quarter does have heavier day content. You price for that across the year, but the fourth quarter 2008 is a higher utilization days than the previous year. And then the ramp-up of the high-deductible plans as evidenced by the increase in CDHP plans in the Legacy UnitedHealthcare product going from 11% to 15% in the fourth quarter. So that does impact the individual quarter not necessarily the full year as you know. You price for that for the full year, but if you've got months that have February utilization, that doesn't in fact impact your loss ratio. So taking all those things in the context, we believe we're appropriately reserved.

John Rex

I mean, maybe I can see this way, is your view of utilization in the 4Q '07, is it that it was higher than even your revised view of 4Q '06?

Stephen Hemsley

No.

Mike Mikan

Not at all.

Stephen Hemsley

No, that it's a -- all that was reserving issues, we talked about in the first quarter and…

John Rex

Right. Okay. So I mean just reading in and it just an 83 plus a little bit versus an [81.7], I'm just trying to understand if there is something in the book of business that shifting that I need to be thinking about more?

Stephen Hemsley

No, I think it's all the reconciling items that I referred to you. I don't think there is anything else to it.

John Rex

Okay. Thanks.

Stephen Hemsley

Before we conclude if I can -- had a recap in a nutshell. We performed to the high end of 2007 guidance in operating and per share earnings for the quarter and the year. UnitedHealthcare commercial ratio for the quarter performed largely in line with our previous statements and we have reaffirmed our commercial care ratio for '08 in an 82% plus or minus 50 basis point range.

First quarter membership appears roughly to be in line with our Investor Day discussion. Higher premium yields from pricing actions are taking -- are getting traction and are being realized. Medicare or Medicaid and supplemental products all appear to be in line with for '08 membership projections.

2008 revenue estimates in annual operating earnings and per share outlook remained unchanged. First quarter per share earnings should be as much as 14% above the prior year quarter, and we expect roughly 7 billion in operating cash flows for '08 and will continue our share buyback program. All of these elements, all of these represented a significantly stronger level of visibility and momentum compared to where we were this call last year and we will continue to focus on improving our performance as we go through 2008.

Thank you very much for you attention today.

Operator

Ladies and Gentlemen, that does conclude our conference for today. You may all disconnect, and thank you for participating.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!