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Executives

Regina Nethery - Vice President Investor Relations

Mike McCallister - President and Chief Executive Officer

Jim Bloem - Senior Vice President and Chief Financial Officer

Jim Murray - Chief Operating Officer

Art Hipwell - Senior Vice President

Kathy Pellegrino - Vice President and Acting General Counsel

Analysts

Matthew Borsch – Goldman Sachs

Charles Boorady – Citi

Bill Georges – JP Morgan

Josh Raskin – Lehman Brothers

Christine Arnold – Morgan Stanley

Greg Nersessian – Credit Suisse

Scott Fidel – Deutsche Bank

Justin Lake – UBS

Carl McDonald – Oppenheimer

Matt Perry – Wachovia Capital Markets

Peter Costa – FTN Midwest Securities

John Rex – Bear Stearns

Doug Simpson – Merrill Lynch

Humana Inc. (HUM) Q4 2007 Earnings Call February 4, 2008 9:00 AM ET

Operator

At this time I would like to welcome everyone to the Q4 2007 Earnings Release Conference Call. [Operator Instructions] I would now like to turn the call over to our host Regina Nethery, Vice President Investor Relations.

Regina Nethery

Good morning and thank you for joining us. In this morning’s call Mike McCallister, Humana’s President and Chief Executive Officer and Jim Bloem, Senior Vice President and Chief Financial Officer will briefly discuss highlights from our fourth quarter and full year 2007 as well as comment on our earnings outlook.

Following these prepared remarks we will open up the lines for a question and answer session with industry analysts. Joining Mike and Jim for the Q&A session will be Jim Murray our Chief Operating Officer, Art Hipwell, Senior Vice President and Kathy Pellegrino, Vice President and Acting General Counsel.

We encourage the investing public and media to listen in to both managements prepared remarks and the related Q&A with analysts. This call is being recorded for replay purposes, that replay will be available on Humana’s website www.humana.com later today. This call is also being simulcast via the internet along with a virtual slide presentation. For those of you who have company firewall issues and cannot access the live presentation an Adobe version of the slides has been posted to the Investor Relations section of Humana’s website.

Before we begin our discussion I need to remind each of you of our cautionary statement. Certain of the matters discussed in this conference call are forward looking and involve a number of risks and uncertainties. Actual results could differ materially, investors are advised to read the detailed risk factors discussed in our most recent filings with the Securities and Exchange Commission. All of our SEC filings are available via the Investor Relations page of Humana’s website as well as on the SEC website.

Additionally, investors are advised to read Humana’s fourth quarter 2007 earnings press release issued this morning, February 4, 2008. This press release and other historical financial news releases are also available on our website. Finally, any references to earnings per share or EPS made in this mornings call refer to diluted earnings per common share. With that I’ll turn the call over to Mike McCallister.

Mike McCallister

Good morning everyone and thank you for joining us. The financial results we are reporting this morning reflect another year of significant growth for Humana, further demonstrating our ability to anticipate and focus on the needs of our varied consumers and customers. Through innovative plan design, clinical programs, financial forecasting and consumer education combined with solid operational execution we continue to deliver a compelling value proposition to our growing membership base.

Our value proposition is built around the idea that consumers, if offered actual information and guidance are just as capable of making savvy cost effective decisions in healthcare as they do in their other purchasing choices. In 2007 this approach produced a record breaking year for membership, revenues and net income on top of a similarly record breaking 2006. The combination of leverage from our growing Medicare membership base, higher commercial pre-tax margins and the continued solid performance of our Military Service business, aligned to achieve record earnings per share again in 2007.

The $1.43 per share Humana earned in the fourth quarter of 2007 contributed to EPS for the full year of $4.91 approximately 69% higher than the $2.90 we earned in 2006. Our fourth quarter came in above our previous expectations due to a lower than expected effective tax rate for 2007 and earnings from a venture capital gain. Two thousand seven was an unusually strong year for earnings growth as membership increases and operational execution amplified the full year benefit of the doubling of our Medicare Advantage membership in 2006.

As Jim Bloem will explain we anticipate $0.05 per share of additional 2008 benefit due to the lower 2007 effective tax rate. Accordingly, this morning we raised our 2008 earnings per share guidance to a range of $5.35 to $5.55. With continued membership growth and strong operational execution driving these results. Let me briefly recap our most significant accomplishments of 2007. In our Government segment our Medicare Advantage membership came in slightly better than previously forecast with ending membership of 1,143,000 representing a growth rate of 14% versus the prior year.

Medicare operating margins were slightly above our 5% target driven primarily by the final Part D reconciliation for 2006. In June of this past year we submitted our 2008 Medicare Plan bids similarly targeting an operating margin of approximately 5%. Just as importantly we made further progress in engaging senior consumers as evidenced by preliminary data indicating the shift to more proactive care by our senior members. For instance 34% of our new senior members completed Humana health assessments in 2007 compared to 24% new members in 2006. This is important because the health assessment provides a vital roadmap for positive behavior change for such programs such as Silver Sneakers and Personal Nurse.

Another example of our progress is with our Heart Failure Disease Management Program. Between February and August of 2007 our senior members in this program raised their drug compliance rate from 82% to 88% a significant stride forward. These are just two examples where care coordination across all product lines including private fee for service is beginning to gain traction and improve clinical results for seniors while offering real hope relative to the managing of costs in the Medicare program over the long term.

Also in our Government segment our Military Services Unit is fully prepared to respond to a formal RFP for the next round of contracts once it’s issued. We are confident that we will offer a compelling proposal which highlights our deep experience with this unique product including our exemplary service to beneficiaries during the past 12 years. In 2007 our Military Services Unit also achieved success with its VA contracting when it was successful over six competitors in being awarded all four contracts for the Department of Veteran Affairs first ever network demonstration project know as Project HERO.

In the Commercial segment we are quite pleased with our improvement in 2007 and anticipate further progress in 2008. In fact, improved operating results in 2007 made up for approximately $50 million in venture capital gains that this segment benefited from in 2006 but did not recur in 2007. Additionally, our provider networks continue to expand and improve reflecting the synergistic effect of the growth in our Medicare business.

We also significantly broadened our portfolio of offerings in the growing specialty benefits market from two acquisitions completed this past quarter. CompBenefits in KMG America, here again we enhanced our ability to anticipate the needs of consumers who are now more likely to op for these types of offerings than in years past, as well as responding to employers desire for a comprehensive spectrum of benefits and related services that help foster their employees engagement, retention and development.

The Specialty products market is a growing one with industry reports projecting mid to upper single digit growth for this sector over the next few years. With our total Specialty membership now at 6.8 million up from 1.9 million at the end of 2006 we are well positioned to take advantage of this growing market. Integration of these acquisitions is proceeding swiftly due in part to the strength of senior management and the capability of employees at the acquired companies.

We believe that 2007 achievements just described position us well for 2008 both in terms of the existing environment and future trends. Let me touch briefly on what we consider the primary strategic considerations in the external environment for 2008. One, Medicare rate for 2009, two, Medicare sales environment, three, the commercial sales environment and lastly the political environment.

First preliminary payment rates for 2009 Medicare are expected in a few weeks with the final rates due out on the first Monday in April. While we estimate the Medicare rate book rates to be up in line with the medical cost trend in the 4% to 6% a number of technical factors also come into play which CMS details as part of its final rate release in April. Regardless, as we’ve done over the past 20 years we will adjust the benefits to ensure the Medicare medical costs trends matches the net level of premium increase.

Turning to Medicare sales, we are pleased with the results we are seeing to date. With January Medicare Advantage Net enrollment up 100,000. Components of this increase include higher retention levels than we had originally expected indicative of the loyalty of our senior members. Gross individual sales are on track while group sales continue to prove challenging as employers continue a wait and see approach. Consistent with our long stand approach to Medicare as a retail consumer business we prefer individual sales.

There are two main reasons; first, because we can clearly lay out the value proposition we offer directly to the buyer and second, because one to one sales volumes are much more predictable than wholesale employer sales. We expect a greater portion of our gross sales for 2008 will now come from individual Medicare sales. We remain confident with our forecast for Net Medicare Advantage sales of $200,000 to $250,000 for 2008 significantly higher than 2007 with 65% to 70% of this total now anticipated to be effective by April 1st, up from 60% we had previously forecast.

With respect to the Commercial sales environment our membership forecast continue to reflect strong pricing discipline. The Commercial group sales environment is still very competitive with the most heated competition from mid to large groups and national accounts. Consequently, most of our group sales have come in the smaller case sizes. Our individual product Humana One also continues to show strong growth as is our Smart Family of consumer focused products.

Finally, I’m often asked about the current political environment and the presidential candidates various proposals for health reform. Each of the candidates brings a thoughtful perspective to the many healthcare challenges our national faces. At the end of the day we believe each of the candidates proposed plans can lead to opportunities for our sector as a whole and Humana specifically. With respect to Medicare specifically we have a long history of working successfully with leaders of both parties in Congress and the White House.

In addition, we believe the combination of Humana’s expanding marketshare, wide spread geographic presence and high rates of program wide enrollment as well as high rates of senior satisfaction come together to lessen the likelihood of significant changes to the Medicare program over the next several years.

Turning now to more detailed look at our Medicare business we are particularly pleased with the growing interest seniors are showing in our Medicare HMO and PPO products. In fact, nearly half of our net enrollment growth in Medicare Advantage products through January has come from our PPO offerings. From the sales distribution perspective our career agents continue to account for the vast majority of our gross sales contributing approximately 75% of the total.

As we said on past calls the remainder of our sales comes through the Humana and CMS websites and exclusive broker arrangements. We believe our unique distribution system results in a high quality sale and ultimately better membership retention. One of the best assets our career agents and exclusive brokers have in selling our Medicare PPO plans in the expansiveness of our network scope. Our PPO network was not built overnight, in fact it’s the result of more than two years of effort, those efforts continue with full force today.

We are constantly striving to make the existing networks more robust while simultaneously expanding the geographies that our PPO networks cover. We anticipate continuing as the leader in PPO offerings, the type of benefit plan that most aging and baby boomers have and are happy with it in the workforce today. In addition, as I mentioned earlier, increasing commercial synergies from our Medicare network are leading to enhanced bottom line growth as the next slide shows.

As you can see from this slide we gained a lot of ground in 2007 in terms of commercial operating earnings. As we expected on a very small portion of our 2007 commercial pre-tax earnings gained from ventured capital gain, while venture capital gains in 2006 were fairly significant. This slide clearly shows the progress of our commercial operations made in 2007. By strategically drawing our individuals, small groups, consumer and self funded products in a price disciplined manner while adding our recent specialty product acquisitions we expect to build successfully on our commercial segment progress again in 2008.

In summary, we again completed a record breaking year for revenue, membership and net income in 2007 and expect another in 2008. Our consumerism strategy continues to prove its worth across the board, but especially in Medicare which we’ve always operated as a one to one consumer business. Our 20 plus years of effectiveness in Medicare in virtually every type of political environment positions us well with continuing national conversation on healthcare reform.

Our overall strategy combined with accelerating senior demographics for which we carefully prepared positions us for continued long term growth and success. The then and now comparison in this chart gives a sense of how quickly and how effectively we have transitioned in just a short period of time and especially in the last two years from a super regional company offering traditional health benefits in pockets of the US to a truly national enterprise with across the board capabilities in a wide variety of benefit offerings.

With that I’ll turn the call over to Jim Bloem.

Jim Bloem

Good morning everyone. In this mornings financial discussion I’ll focus on the following six areas; first, the drivers of our better than expected earnings in the fourth quarter and our raised earnings guidance for 2008. Second, the major factor impacting the quarterly pattern of our 2008 Medicare benefits ratio which again this year is expected to be the primary driver of our quarterly earnings pattern. Third, the continuing reliability of our commercial pricing and benefit expense trend analysis and their role in our increased pre-tax margins and profit.

Fourth, the rationale for and benefits from our SG&A spending. Fifth, our investment portfolio strategy in these uncertain times and our commitment to maintaining a debt to capitalization ratio within a consistent range. Sixth, our expectations are on 2008 cash flows from operations.

Let me begin with a brief summary of what changed versus what our prior expectations both for the fourth quarter of 2007 and as we move into 2008. As noted in the press release the lower fourth quarter tax rate reflected two items which we had not anticipated. The first and more substantial of the two reflects a lower overall state tax rate. As our company has expanded geographically our earnings have become more allocable to more states. Many of these states have lower tax rates than the smaller group of states where our earnings previously we dry.

Last month as we completed our 2007 year end state tax accruals it became apparent that we had underestimated the impact of this change. Consequently the lowering of our state tax rate added about $0.06 per share in earnings to the fourth quarter over our previous guidance. The second fourth quarter tax related item adding about $0.03 per share related primarily to a better than expected resolution of an audit item with the Internal Revenue Service.

Finally, also in the fourth quarter we recorded $0.03 per share related to [inaudible] from the sale of venture capital investment that was realized on December 31st. We continue to expect little or no contribution to the earnings from the sale of venture capital investments in 2008. In evaluating the impact of the lower 2007 tax rate on 2008 the lower state tax rate is the only item having a recurring effect. We now anticipate that our effective tax rate for 2008 will be in the range of 35.5% to 36% versus our prior expectation of a range of 36% to 37%.

Accordingly, we raised our 2008 earnings guidance this morning to reflect this change. In terms of how our 2008 earnings per share guidance of $5.35 to $5.55 is expected to be earned among the quarters we are forecasting a more front weighted quarterly earnings pattern for 2008 versus 2007. In today’s press release we guided you to first quarter ’08 earnings per share in the range of $0.80 to $0.85. Additionally we expect that 71% to 75% of our annual earnings for 2008 will be achieved by the end of the third quarter. This compares with around 70% in 2007; this front weighted pattern is primarily due to quarterly pattern of the Medicare benefits ratio which I’ll discuss now.

As one might expect the Part D benefit structure creates much variability in the Medicare benefits ratio between the quarters. However, just as 2007 was significantly different than 2006, 2008 is different from both of them. Now what’s the same is that when we project our Medicare benefits ratio quarterly pattern for 2008 we continue to anticipate a pattern that’s somewhat similar to 2007 with the ratio being the highest in the first quarter and the lowest in the fourth quarter as dictated by the Part D benefit design.

However, the 2008 quarterly benefit ratio progression will be less pronounced versus 2007 as shown by the illustration on this slide. The primary factor driving this less pronounced pattern is the composition of our 2008 PDP membership which has changed from last year. We have nearly 300,000 fewer low income senior members effective January 1st. With a higher percentage of non-low income seniors in our enhanced plan and a lower percentage of non-low income seniors members in the complete plan.

The decline in the percentage of low-income members is particularly relevant in analyzing the quarterly patterns because these seniors have a steeper declining slope to their quarterly benefits ratio progression versus the remaining Part D members. With the first quarter ratio much higher on low incomes than the overall average and the fourth quarter much lower. Consequently our lower membership in the low income block is anticipated to lower the quarterly benefits ratio pattern in the first half of the year and raise it slightly in the back half of the year compared to 2007.

Another factor in the quarterly benefits ratio pattern is the widening of the Medicare Part D share quarters. All things being equal which of course they never are this change would likely reduce the size of the Part D risk share balance at the end of each quarter. However, the magnitude of this factor on each quarter’s benefit ratio is not all that significant. Here’s the twofold take away, the composition of our PDP membership will have a significant impact on the quarterly pattern of our Medicare benefits ratio without necessarily impacting the full year ratio. Secondly, the 2008 quarterly Medicare benefits ratio pattern is expected to drive our quarterly earnings per share for this year.

Turning next to our Commercial segment, 2007 marked another year of improving pre-tax margins and profits. This performance continues to be driven by first our consumer focused strategy, second, the sustained pricing and underwriting discipline that we practice, third, our continuous benefit expense trend analysis and forecasting, fourth, our integrated guidance solution and our clinical model, fifth, the achievement of a well balanced membership portfolio in the consumer segment and finally the benefits of scale that our Medicare membership has on our commercial provider networks.

Our rigorous benefit expense trend analysis and forecasting includes regular interaction of many disciplines within our organization, this increases the reliability of our commercial pricing and profit planning. At the beginning of 2007 we guided toward same store cost trends around 7% with trends adjusted for our business mix netting to about 5% for the full year 2007. Now that 2007 is over I’m pleased to report that these trends fell right in line with our expectations with same store cost trends coming in at 6.7% just slightly better than the 7% trend we had originally projected. We expect these same store trends to again run between 6% and 7% in 2008.

With respect to secular cost trend components, i.e. these are the annualized trends before benefit buy downs, there were no surprises here either. We saw inpatient utilization trends come in flat to negative for 2007 and we expect something close to flat again in 2008. For hospital rates both inpatient and outpatient we experienced a trend which continued in the low single digits, while physician costs averaged in the mid to high single digits both of these were in line with our forecast.

Finally, also as expected prescription drug trends were in the mid to high single digits. Based on our ongoing deep dive analysis of benefit expense trend factors we do not foresee any significant changes to the components of our cost trends as we move into 2008, as is stated in this morning’s press release. Accordingly we remain confident of our ability to meet our 2008 commercial pre-tax earnings target of $280 million to $300 million. We look forward to sharing our progress with you each quarter.

Now let’s review our SG&A spend. Consolidated administrative expenses increased from $829 million in the third quarter to just over $1 billion in the fourth quarter. About two thirds of this sequential increase was due to additional expenses associated with the 2008 open enrollment period for Medicare. This includes such expenses as marketing, advertising, commissions, postage, printing, and etcetera. The majority of the remainder of the increase in administrative expenses from third to fourth quarter 2007 was attributable to the acquisitions of CompBenefits and KMG America.

The increase in expense associated with the 2008 open enrollment period versus the amount spent in 2007 was in proportion to our higher Medicare Advantage membership goals this year. As the slide shows, open enrollment periods of the first quarter ’06 and the fourth quarter ’06 were marked by the higher spending reflected in the SG&A expense ratio represented by the blue bars and with the dollar administrative spend represented by the green line.

In all cases the result was an increase in Medicare Advantage enrollment in subsequent quarters which is represented by the red line demonstrating the efficacy of these expenses. In 2008 we expect consolidated SG&A ratio between 13.5% and 14% which is the same range as we projected and achieved in 2007. The 2008 consolidated SG&A ratio range includes a full year of the higher SG&A ratio of businesses of both CompBenefits and KMG America, which combined if not offset by productivity gains we add approximately 400 basis points to the expected 2008 consolidated SG&A ratio over 2007.

Focusing next on our investments and debt our $6.6 billion investment portfolio continues to perform well and in line with our expectations, despite the ongoing turmoil in the credit markets. This consistent performance is the result of our total strategies of variable rate and high credit quality, investments and debt. Keeping our investment returns and interest expense rates variable helps immunize our income statement form the volatility of the rapidly changing short term interest rates that all of us have experienced since August.

Generally, as shown on this slide, when short term rates fall both our investment income and interest expense decline but the difference between them remains relatively constant. Now with respect to credit quality the other half of our investment strategy we currently maintain a $4.5 billion fixed income portfolio and a $2 billion in cash equivalents with average credit ratings of AA+ and day one respectively by Standard & Poor’s. These investments also have the equivalent ratings by the other agencies.

High credit ratings coupled with a relatively short duration period of around three and a half years which matches the corresponding short life of most of our liabilities provide additional liquidity and financial flexibility in periods of credit concerns and interest rate volatility like the present. With respect to the well publicized sub-prime situation we acceded to $8.1 million of sub-prime and second lien mortgages with one of our fourth quarter acquisitions.

However, by the end of January we have reduced that amount to $4.4 million and we’re comfortable with the remaining securities that we now own each of which has maintained at least a AA rating after subsequent reviews by the credit agencies. We do not have and have never had any collateralized debt obligation or structured investment vehicles in our investment portfolio.

Turning to our interest bearing debt, our debt to total capitalization ratio at December 31, 2007, was 29.5% that compared with 29.4% at the end of 2006. During the fourth quarter we borrowed $350 million off of our bank credit facility to partially finance the CompBenefit and KMG America acquisitions which had an aggregate cash purchase price of approximately $560 million. This raised our debit to cap ratio from 25.7% at the end of September. We remain committed to keeping this ratio in the range of 25% to 30%.

Turning last to cash flows, as you can see on the slide the fourth quarter payment of the $726 million for 2006 Medicare risk share payables resulted in a $1.2 billion of cash flow from operations for 2007. Based on the higher net income as well as a higher depreciation amortization expenses expected in 2008 we anticipate cash flows from operations up between $1.5 billion and $1.8 billion after paying back approximately $100 million of 2007 Medicare risk share payables to CMS this year.

Capital expenditures are projected to be approximately $275 million mainly for technology and to a lesser extent fixed assets required to more effectively serve our growing membership and to integrate our recent acquisitions. These capital expenditures will be partially funded by an estimated $235 million depreciation and amortization expenses.

With respect to cash available for possible acquisitions and other uses, we expect that to increase also in 2008, in addition to a significantly lower 2007 risk share payable versus the one we had for last year, we expect the capital contributions required to be made to our operating subsidiaries will be lower than the $307 million we made in 2007. We plan to give you an update with respect to cash available when we report our second quarter earnings on August 4th.

With that we’ll open the phone lines for your questions. We request that each caller ask only two questions in fairness to those waiting in the queue.

Question & Answer Session

Operator

[Operator Instructions] Your first question comes from Matthew Borsch from Goldman Sachs.

Matthew Borsch – Goldman Sachs

I was wondering if you could talk about the rate outlook for Medicare Advantage for 2009. I know we’ll get that I guess on April 7th, and you sort of mentioned 4% to 6% as a starting range. Can you just talk through the other items that you think may impact that outlook for the current year?

Jim Murray

There’s a lot of actuary to our very into this and are a lot smarter than me but Mike mentioned earlier that the range relative to the increase for trend would be somewhere around 4% to 6% and we see that being the case similar to what its been over the last several years. There are probably four or five technical adjustments that the CMS is looking at, things like budget neutrality which you all are very familiar with and fee for service normalization. There’s also an item that comes up every couple of years called recalibration of the NA risk factors that we are anticipating that will be something relative to that.

When we put all of these pieces together we look at what we are likely to get in terms of a gross increase from CMS and we don’t think its going to be significantly different than what it’s been over the last couple of years. Then the net amount that we would enjoy after the MRA work that we do will probably be very similar to what we’ve seen over the last couple of years. Again, we only anticipate significant differences and depending upon where it all falls out, county versus county and our membership versus others. We’ll do whatever is necessary to adjust benefits to make our 5% margin requirement that we’ve talked with you about many times in the past turned out to be 5%.

Matthew Borsch – Goldman Sachs

You alluded to employers being on the fence and taking a wait and see attitude with respect to group MA sales. What is it going to take for that to change, does it really relate back to the uncertainty over reimbursement policy and so we’d probably need to get well into the next administration before that changes, or is there another factor at work?

Jim Murray

Flippantly I would say it would be an act of God but I just got kicked under the table. We are seeing a lot of things happen; the larger the companies are the more we see reluctance. I would say Jim referenced the sub-prime earlier, I would anticipate that that would have a significant impact on the government agencies that have retirees and so over the next several months and year I would anticipate that we’ll see more activity from states and local governments that need budget relief and we are working with them closely.

The smaller the company that has, for example there’s many companies out there that have 200, 300, 1,000 retirees that seem to be using our services and we are pleased about that but it’s the larger companies that we aren’t seeing yet make the decision, although there is a lot more activity with the consultant community. To your point, perhaps more certainty around rates from the Federal government will get the companies that are larger, more comfortable with our solution.

We’ll play that out, the way we are beginning to think about this is that we want to focus on individual sales and hit it out of the park with individual sales and if any of these group opportunities avail themselves that’s just going to be gravy because we don’t want to count on that any more.

Operator

Your next question comes from Charles Boorady from Citi.

Charles Boorady – Citi

In Medicare Advantage can you break out for us the gross versus net adds and also by product, HMO, PPO versus private fee for service in terms of your new adds in January?

Jim Murray

I think Mike had a graph which was like a pie chart which shows where our gross and net adds came from, I would suggest that probably 50% of the, I think we had about $190,000 gross sales came from network based plans and the net $100,000 as you can see probably 60% or thereabouts were network based plans and so we are very, very pleased with the willingness of the membership to accept PPO and HMO arrangements as is demonstrated in the pie chart.

Charles Boorady – Citi

Did that reflect any switching, or can you talk about switching of existing members our of private fee for service to more network based?

Jim Murray

There was some switching but not significant in terms of the numbers that we are seeing.

Charles Boorady – Citi

In the Commercial pricing it seems like you are assuming an acceleration in medical trend in ’08, is that just conservatism in how you are pricing or are you seeing cost trends hike up?

Jim Murray

Actually I think we are expecting something of a deceleration, we are very, very pleased with what we see developing in the Commercial trends. I think the past year we had a 6.7% trend is what Jim said earlier and this year we are expecting 6% to 7%. I feel very good about what we see Commercial trends doing.

Charles Boorady – Citi

From your guidance table it previously had said a trend of 4.5% to 5% and your new guidance table for ’08.

Regina Nethery

That equates back to the 3.5% to 4.5% in this mornings that includes business mix changes equates to the 4.5% to 5% before.

Charles Boorady – Citi

You are assuming a deceleration, is there a basis for that in terms of what you are seeing in recent trends?

Jim Bloem

Not materially, but again we sight more of the business mix. It’s a 50 basis point improvement and what we tried very hard to say today in my remarks anyway was that we spend a lot of time on this as a company in terms of looking for where trends are going to show and where its going to break and how that gets into our pricing and forecasting. We attribute the fact that we’ve been very consistent in a slight ward down bias in trend to that work.

Operator

Your next question comes from Bill Georges from JP Morgan

Bill Georges – JP Morgan

A follow up question on what you are seeing in terms of trends. There have been some comments recently made around an up tick in volume of orthopedic procedures, perhaps driven by concerns of loss of insurance and or benefit changes because of weakness in the economy. Are you concerned about that, for your commentary you are not seeing it, but is that trend that you’ve seen with historical down turns in the economy and how are you preparing for that if that should happen in ’08?

Jim Murray

We have seen not anything recently but muscular/skeletal costs are one of our largest increasing cost categories and so because we saw that a number of years ago we outsourced some work with a company that specializes in that and we’re rolling that company out to all of our Commercial markets and we anticipate that we’ll see a nice improvement as a result of that relationship.

Bill Georges – JP Morgan

Outside of that though you are not concerned about any sort of macro pressure as a result of people using medical services at a high rate?

Jim Murray

No.

Bill Georges – JP Morgan

A question around capital deployment, Jim I know you’ve talked about this a little bit in the past with growth slowing modestly and somewhat less intense capital requirements you should probably have more free cash in the back half of the year. Can you talk about when you might know about that and what your plans might be?

Jim Bloem

That’s why I said in my remarks, I talked about that by the August 4th call we’ll sort of know where we are on that in terms we will have vetted our position with the state departments of insurance with regard to capital contributions to the subs and to the credit rating agencies with respect to what the deployment strategies would be. We continue as I mentioned in my remarks also we continue to spend on capex and acquisitions both using a criteria that they beat our weighted average cost of capital and raise the value of the firm. There are plenty of opportunities like that as well. You are right that the composition and the expected cash flow for the year are expected to be better than they were in 2007.

Operator

Your next question comes from Josh Raskin from Lehman Brothers.

Josh Raskin – Lehman Brothers

A quick question on the investment income assumptions, Jim did I hear you right in saying that you’re not assuming any further rate changes and if that’s the case what would be the impact of 25 basis points be per se, understanding there is some offset on the debt, I assume still much bigger impact on the investment income?

Jim Bloem

What I said was, is that we would like to have you take home the fact that changes in the rates don’t do that much to the net between investment income and interest expense, that’s because both are variable. You are right we had a lot more investment assets than we have debt so a change generally speaking would make a bigger change in the investment income when rate are falling a bigger downward change. What mitigates against that then is the value the portfolio goes up and then when we also have the ability then to look at the gains that we have there.

Generally speaking because they are a little bit slightly different in how they are geared off of, investment income is geared off the Fed funds rate the debts gear off of Libor and the rates between those fluctuate as well and that’s what really gives us confidence that we think that we’ve affectively immunized the portfolio from changes in rates. Again, you can see investment income went down ten but interest expense went down ten and we expect to see more of that because we haven’t really factored anything more into what the Fed might do.

We’ll deal with those as they come up but we feel in a really good position that those things should not affect materially the net income numbers that we are shooting for this year.

Josh Raskin – Lehman Brothers

I didn’t realize you would include the investment gain, I guess obviously it offset it. The second question, on the Commercial earnings, how much of that ties into specialty acquisition? Thoughts on what you are going to see from your specialty membership in 2008 is it a year calling after the acquisition or you expect to continue to see growth in those businesses? How much of the Commercial earnings is coming from the increase in specialties?

Jim Murray

I’ll take the first part and Jim can take the second part. We would anticipate that our membership in not only the dental and vision but also some of the life STD, LTD that we got with KMG would probably be flat to slightly down over the first couple of months of the year. We are going to hire a number of individuals who will help us with some of these specialty lines in places that we aren’t currently and so we would anticipate as we go in to the third and fourth quarter that there be an acceleration in membership and premiums from these lines.

We are very excited about the prospects, many of you think of us as a regional Commercial carrier, nationally for Medicare, but some of the opportunity that we see, including CompBenefits and KMG is that it opens up a lot of opportunity in all 50 states. The folks from KMG and CompBenefits can now go in with a package of products, group Medicare, stop loss, dental, life, vision, STD, LTD in a lot of the states that we currently don’t have a Commercial foot print.

We are beginning to think more around 50 states for our Commercial foot print than the 25 that we talked about in the past. We are really excited about what’s happening in the environment and our opportunity to capture some of that; we are pretty excited about what’s happened with our specialty lines.

Jim Bloem

To follow that up, as we said when we announced both acquisitions, if you put them both together that we said we’d add somewhere between $0.08 and $0.13 for this year 2008 and we are right on track to be in that range.

Josh Raskin – Lehman Brothers

All of that goes to the Commercial free cash?

Jim Bloem

That’s correct.

Operator

Your next question comes from Christine Arnold from Morgan Stanley.

Christine Arnold – Morgan Stanley

A couple questions, first could you talk about how your pricing, are you pricing assuming a deceleration in medical trend? Could you talk about how you are thinking about that, because I know there’s a mix adjustment? Calculating that the PDP loss ratio probably needs to improve year over year by about 13 percentage points in order to get to the first quarter guidance, am I in the ball park there?

Jim Murray

I’ll take the first question; sometimes I can’t understand the second question. With respect to the first question, I’m sorry I was thinking so much about the second question I forgot the first question could you repeat it?

Christine Arnold – Morgan Stanley

It seems like you are guiding for a bit of a deceleration in…

Jim Murray

Absolutely not, we are anticipating some improvement quite frankly in our medical expense ratio year over year we are really going to try to price flat with where we are currently at in terms of trends and try to improve some of the MER much similar to what you are seeing happen last year versus this year. I would anticipate some margin enhancements there. We told a lot of folks that have come in over the course of the last year that we want to improve our Commercial margins. I think we are pretty close to four for 2007 with a target of ultimately getting up to six. We would anticipate some improvement in the medical expense ratio as well as the admin ratio going forward. That’s our goal is to get to six over the next year or so.

Jim Bloem

You are right directionally in terms of the PDP benefit ratio, what we had said, based on the low income fees there is going to be quite a difference in the front end of this year versus last year and it has to do with having fewer low income. The percentage of 13 basis points that you sighted is a little bit high, it’s not quite that much but we didn’t say what it was going to be. We are guiding to our overall Medicare benefit ratio but you are right on track in terms of the first quarter will show a dramatic improvement in the benefit ratio.

Christine Arnold – Morgan Stanley

That implies year over year improvement in Medicare Advantage and Commercial if the PDP is less than I’m thinking because you’ve outlined SG&A expenses are going to be flat on the dollar basis on your slide is that an accurate rendition of reality?

Jim Bloem

Yes, you’ve got to also take into effect we have more members, we have greater scale. Again, looking at the guidance we’ve given of the $0.80 to $0.85.

Operator

Your next question comes from Greg Nersessian from Credit Suisse.

Greg Nersessian – Credit Suisse

My first question was, Mike, you mentioned the synergy income impact on the Medicare business and your Commercial provider relationship, could you just talk through that a little bit more, is that a function of just having a broader network and that favorably impacting sales or are you actually seeing better rates and better discounts from those providers?

Mike McCallister

I’ve talked about this some in the past, there’s an evolving thing going on around the country where are two things converging together here. One is that, put Medicare aside for second, generally in the Commercial business hospital systems who largely dictate the competition on the payer side are awakening to the fact that they don’t have an awful lot to gain by advantaging one payer over another one.

We are finding places around the country where we are actually just purely on a Commercial basis being invited into the community and being given a competitive pricing schedule with not the usual leverage that you would think you would need. That’s one piece and then you overlay the fact that we are showing up in lots of communities with all these Medicare products and a brand that is becoming pretty well know because we are obviously promoting Medicare pretty strongly.

We are in the community already, we are building PPO networks, which I’ve talked about a lot, so we actually are going into hospital systems and talking to them about the Medicare PPO and while we are there we are looking to find out whether any of these systems are in a position where they get it relative to pricing on the Commercial side. What we are finding is a fair number of them are. It’s been a nice synergistic opportunity, we go in, we talk about Medicare PPO’s, that’s something we’ve been able to get done and then we talk about market competitive pricing on the Commercial side.

Frankly, if we don’t get market committed pricing we don’t kill any trees to produce a contract. We just don’t do it. We have a hand full of states I’ve talked about in the past where we find ourselves, even though we are relatively small compared to the imbedded interests that are already there with market leading hospital pricing and the rest of the provider community usually follows along quickly. An interesting development, it’s going to take a long time for it to have a huge impact on Commercial growth because you still have to introduce yourself to the employers and the distribution system, consultants and all that.

It’s all kind of coming together and its really been rather fascinating and we are benefiting from it in a handful of places in the short term and I think we’ll do a lot better over the long term, especially when you consider the voluntary benefits that are going to start finding there way in these employers across the country too. All of its coming together and introduce us in a lot of places we wouldn’t have been four or five years ago.

Greg Nersessian – Credit Suisse

My second question was just a little nuance on the Commercial cost trend, it looks like the pharmacy is now mid to upper single digit guidance for ’08 it had been I think high single to low double. Some of your competitors are suggesting its going to go the other way in ’08; it’s actually going to be higher because of the number of generic launches last year. Is there something specific to Humana that’s going on there or if you could just describe that a little bit more?

Mike McCallister

I think that basically what that is we continue to increase our generic penetration, the more mail order on each side. I think those things are sort of countering a little bit what you are saying of us.

Greg Nersessian – Credit Suisse

What is your generic penetration rate?

Mike McCallister

In the Medicare part in 2006 it went from about in the 60’s to the low 70’s on the Commercial side 55 to 60, ’06 to ‘07.

Operator

Your next question comes from Scott Fidel from Deutsche Bank.

Scott Fidel – Deutsche Bank

First question on the Commercial enrollment guidance, it actually looks like you raised that a bit to 65 to 90, 5,000 adds from 50 to 75 and just wondering what’s driving the increase in enrollment guidance? Also, what type of assumptions you are building in to the employers launch or segments just relative to potentially higher attrition from the weakening economy?

Jim Murray

The growth that we are seeing is primarily in four areas, it’s the individual, the individual business for us is doing extremely well, we introduced a new product during the middle of last year and its having a nice impact and also some tools for our brokers to do business with us a lot easier and so our individual membership is growing nicely month after month. The small group business for us is doing well, it probably net adding anywhere from around 1,000 or 2,000 members per month which is good.

We are also seeing some nice lift recently with our portfolio book of business. We’ve done a lot as many of you who have been in here and talked with us over the course of the last year we’ve worked hard to rehabilitate our portfolio book of business that looks like its now paying some nice dividends, we are seeing some nice but not great growth in our portfolio which is a shift from it had been shrinking over the last several years and we are seeing some nice rates coming in on that, we are pleased by all that.

Around all of that our consumerism offerings are also doing well, we came out with a new offering recently called Smart Results which is a trend guarantee for ASO business that we’ve got about 20 customers out there that we are using as kind of a beta site test and it got us a lot of nice buzz in the broker community for being innovative and creative and so we are excited about that. A lot of the growth that we are seeing is in the smaller case sizes there is, as you said, some fall out from some of the national accounts and some of the larger companies where they are downsizing, what have you, and we have that baked into the estimates that we’ve given you.

What you are going to see from us frankly will probably be a shift to the small case sizes over the next several years as we begin to focus more and more on those more profitable case sizes going forward.

Scott Fidel – Deutsche Bank

I’ll ask a follow up around Part D, it looks like you increased the lower end of your guidance range for that for ’08. I’m just wondering is that coming from less attrition in the LIS auto assignment process or from better new sales you are seeing in PDP?

Jim Murray

It’s a little bit of all of those but what we are happy about is that we saw a lot of seniors who decided to stick with us regardless of some of the rates that we put out there because of the LIS situation we’ve talked about in the past. We are pleased with what must be a nice value proposition for those seniors and we are pleased with the complement of membership that we kept mostly in the voluntary area is where we are seeing a nice retention.

Operator

Your next question comes from Justin Lake from UBS.

Justin Lake – UBS

A couple questions on enrollment in Medicare Advantage. First you did a great job of giving granularity last quarter around the components of Medicare Advantage growth this year and how they were going to better than last year and obviously you felt that employer Part D up selling open enrollment and then agent. It sounded like it was going to be about 25% of growth from each. Can you give us some, obviously you’ve mentioned the employer side being a little bit weaker, can you give us some idea of how those, all four of those components are trending and where you see that 200 to 250 coming from now that you have a little bit more visibility?

Jim Murray

The way that we are trying to focus on it is that our career agents are doing really well for us. When we talked the last time we anticipated that they were going to provide a certain level of growth and they are doing better than we had anticipated before. We are also doing better in retention than we had envisioned so getting more from our career agents and retaining more of the membership that we had before is serving to make up nicely for the shortfall that we are seeing in the group business.

We are pleased with the number of network based sales that we’ve made as a company we think that portends well for the future as more and more this has to move to a network based solution over the next several years and we are really pleased with where we are at as a company not only in creating the networks but also convincing people as to the value of moving into those network based options.

Mike McCallister

I think if you take anything away from this call this morning relative to Medicare Advantage its around the idea that the individual purchasers are opting for this in very large numbers; number one and number two those that are buying it stay with it. I think that’s really, you hear us all the time about being a conservative business, retail all those sorts of things, you are seeing it play out here, that’s the type of business at the end of the day we would prefer to have.

If we end up with some group Medicare that’s great. Jim mentioned earlier we would consider that icing on the cake and we would. Our focus is on the Medicare individual buying our product based on the value proposition we pitch because we know based on our relationship with them they are likely to stay with us. The big news in this quarter is you are actually seeing that play out a little better than we would have thought even a few months ago. We’ve always believed it and it’s nice to get validation from the customer.

Justin Lake – UBS

A follow up question on the first quarter guidance, last year I think you were at about the same spot when you gave us an update for January at plus 100,000. By the end of the quarter you had added another 10,000 members, you were plus 110,000. This year it sounds like you are looking to be closer to 140,000 to 175,000 if I’m doing that math right. Can you give us some visibility on what is giving you confidence that you are going to add so many more members in that February, March time frame versus what you did last year?

Jim Murray

We track sales on a daily basis so we are seeing what’s happening in January for a February effective date and I’m already seeing how many we are selling during February for a March effective date and we periodically get tapes from CMS that tell us how many terminations and based upon everything that I’ve seen and what I know that our targets are for February 1st effective and March 1st effective and April 1st effective I feel pretty good about what we are seeing and how that portrays what we’ve done in terms of guidance.

Justin Lake – UBS

I’m not questioning the guidance, I’m just asking is it more growth sales or is it less attrition or is it half and half?

Jim Bloem

Probably a little bit more retention than it is gross sales.

Mike McCallister

Part of that is the market keeps changing too, we are not dealing with the same competitive posture that we had a year ago relative to some have become less competitive. We learn every year, we continue to fine tune the products, benefits, prices, all those sort of things. I think when we sit down and project what we are going to be able to do we are looking at everything relative to what our capability is, the metrics around the sales and distribution process as well as at the end of the day where our products offerings stand up in the marketplace and that’s how you get comfort is that individual buyers will in fact choose you over someone else.

Operator

Your next question comes from Carl McDonald from Oppenheimer.

Carl McDonald – Oppenheimer

In the past you’ve given us some medical loss ratio differences at least roughly between the privacy for service and the more network products. I was wondering if you could update that for 2007 and also give a sense if that is going to change in ’08 with the greater weighting toward the PPO?

Jim Bloem

I don’t think that we have given official numbers out I think we’ve said that we think they are kind of equal. I had no problem with the privacy for service medical expense ratio versus PPO versus an HMO but I will tell you that our strategy as a company is beginning to share with folks the choice that’s available with network based options and as folks move into that it really doesn’t impact our overall 5% margin target that we have focused on for years and years and years.

That’s the way we think, a PPO and an HMO and privacy for service all create a 5% target but philosophically CMS and us want more people to move into network based options over the next several years.

Carl McDonald – Oppenheimer

To clarify you commentary you still think there’s a loss ratio between those products is fairly similar.

Jim Bloem

Very similar yes.

Carl McDonald – Oppenheimer

The second question, I would be interested in your updated view on the medical RFP and the timing of when you think that will be issued.

Jim Murray

That’s one of those act of God things again. We keep hearing that it was going to be in October then it was going to be November so I frankly have no idea when it’s going to come out. I know that our contract is up 3/31/09 and so we are starting to get tight in terms of the ability to put out an RFP for us to respond to it for the government to evaluate it and then for the transition process to begin. As we understand it there is going to be a pharmacy RFP that comes out before the medical RFP so again I have no idea as to when the final RFP is going to come out and what they are going to do in terms of timing. We’ve seen that from start of the RFP till the award is taking anywhere from six to twelve months so again its got to happen fairly quickly because now we are starting to deal with a contract end date.

Mike McCallister

History would tell you that there’s little change of this happening without some sort of extension. It could be short, it could be long or who knows. We really are up against the timing situation now that would make it, based on history, difficult to actually do.

Operator

Your next question comes from Matt Perry from Wachovia Capital Markets.

Matt Perry – Wachovia Capital Markets

I was trying to understand your comments from the slides would indicate that the higher SG&A spending would kind of correlate to higher Medicare Advantage adds yet in January of ’08 you added 100,000 and in January of ’07 you added 100,000. Is there a disconnect there or is some amount of that spending really only going to benefit growth later on after January?

Jim Bloem

It’s really the goal we are talking about, the goal for last year was roughly, I’d say the mid point of the goal was around 150 and this year mid point of the goal is around 225 so it’s a 50% increase and when it occurs as Jim says we are constantly monitoring the activity and what’s going on and so that’s really what gave rise to the proportionality and the decision to spend and what the opportunity was.

Mike McCallister

I’d even go further; looking at year over year is a big mistake. This is an annual exercise relative to presenting products to seniors and every year we go through a bidding process, every year we get stacked against our competition. Every year we enter the market knowing exactly where we stand and the likelihood of being able to sell. I think we have to be opportunistic and we will do that and so I think the actual spending could vary up and down year to year depending on what’s possible in the marketplace and what our goals are, as Jim would say.

I would encourage everyone you have to think of Medicare as two things; an annual event where everything happens at the same time and number two a consumer business. Those two things change your mindset about how this industry works. It is not a traditional wholesale employer environment we are dealing with, this is truly a consumer marketplace. It changes everything so as we look year over year we may jump all over something in the fourth quarter of this year based on what we learn about where we are relative to ’09.

I think at the end of the day history would tell everyone here that we’ve been pretty good at being opportunistic about this opportunity and we will continue to do that.

Jim Bloem

When we spend the money we get the results.

Matt Perry – Wachovia Capital Markets

From your comments it sounds like attrition is a little bit lower and the group sales are also a little bit lower. Any kind of positive or negative surprises on the PDP up selling so far or where the agents sell?

Jim Murray

No, Mike talked about this in some of his remarks, its pretty remarkable that we can look and see how much of a spend we have for a particular, for example how much we spend for a cable ad and how many calls that will drive and then we have statistics around how many of those calls will convert to a lead and how many of those leads that will convert to a sale and how many of those sales will result in a referral of friend or a family member. It’s remarkable and all of the different sales channels that we have, direct mail versus a cable TV.

That’s pretty predictable and there are a lot of levers that we pull. Nothing has surprised us this year; we talked last year when we were together that we were surprised with some of our competitors and some of their benefit offerings. Nothing really has been a big surprise for us this year.

Matt Perry – Wachovia Capital Markets

Was there any pulling forward of discretionary marketing spend from the first quarter of ’08 into Q4 ’07, based on pretty strong underwriting results did that cause you to look at the opportunity a little bit differently and spend a little more?

Jim Bloem

As Jim said we really look at activity, we really try to figure out where can we put these dollars to get the results that we really want to get. If you look at things the way it goes, it’s looked at in terms of the goal and then what’s available and what kind of, as Mike says, how are we positioned this year.

Operator

Your next question comes from Peter Costa from FTN Midwest Securities.

Peter Costa – FTN Midwest Securities

Two questions, first one regarding the Medicare Advantage group sales again, you’re changing expectations there, do you think that’s more tied to Humana’s size on the Commercial side and is that just a 2008 view or do you think that’s going to be continuing to see slow sales there overall? First is it just Humana and your size or is it [inaudible]?

Jim Murray

I think what you mean is because we are not nationwide and we don’t have the opportunity to sell Banc of America that we might not be, we don’t see any of those large cases going out to bid right now for group Medicare opportunity. If you look at some of our competitors they don’t have the private fee for service capability that we do and so many of the competitors who might be covering the commercial under 65’s can’t compete with us.

There might be some of what you suggest in there but I don’t think that’s the big driver. I think it’s some of the questions that were asked earlier or some of the opinions that were voiced earlier about some of the larger companies are waiting to see how the rate situation plays out, I believe. I’m also of the opinion that some of the consultant community is trying to get their arms around how this whole thing works and where monies come from and how we are able to do what we are able to do.

I think they are getting more and more comfortable with that. We’ll see how that plays out but again Mike called it icing on the cake, I called the gravy, we’re not going to count on it.

Mike McCallister

Let me say it slightly different but probably the same end, it’s kind of an upside down situation if you look at the commercial market and you look at national accounts and foot prints and who is more national than others than we would not be one of the top couple thinking that way, having said that, the Medicare opportunity for many of these very same large companies requires a national foot print it largely requires at this moment a privacy for service offering over the long term probably a PPO which flips it instead of Humana is the most likely to be able to meet their needs.

We are actually uniquely positioned to actually do it for them should they ever decide to do that much more so than some of their large commercial payers they are accustomed to doing business with. Once again it’s counter intuitive.

Peter Costa – FTN Midwest Securities

No one’s ready right now if you will?

Mike McCallister

Look at the flip side of the table would be the argument.

Peter Costa – FTN Midwest Securities

My second question on the Commercial PMPM’s were much lower on the specialty relative to the acquisitions does that trend lower from here and then the earnings in the Commercial segment were flat or even down if you exclude the venture capital gain. Can you speak to that a little bit in terms of what we should be expecting that going forward, is this a run rate where we should look at it or is it going to decline from here because of the acquisitions?

Jim Bloem

Two things, when you look at the acquisitions, the acquisitions and the products that they sell have lower PMPM’s, when you look at the fourth quarter in comparison you take CompBenefits they have an HMO, dental, sometimes access to networks, etcetera. Those PMPM’s are less than our dental business was. The same with the vision benefits, you could do the same thing on the KMG side. When you look going forward you are going to see lower PMPM’s but again we think that the margins here give us a real opportunity in terms of the other products we sell where employers are looking to move benefits to and to get people involved in and we think that makes them a good opportunity.

On the PMPM part that’s kind of how you get to that. On the earnings, the fourth against the fourth quarter a year ago, the fourth quarter a year ago was a very good quarter in terms of if you remember last year at the beginning of the year this is 2006 I’m talking about, we were somewhat uncertain about our medical cost trends and how they were going to unfold or evolve, they did evolve within the year quite well and that was reflected in the fourth quarter results of last year and that’s why the comparison is so close this year, 53 against 54.

Peter Costa – FTN Midwest Securities

Does that also have anything to do with the individual membership picking up because that probably has a higher deductible so more people going over it in the fourth quarter, is that still a factor?

Jim Bloem

A certain amount but again that’s all in the mix and everything that we’ve talked about how our business our territories.

Jim Murray

The only thing that I would summarize and this is a little bit apart from your question, we’ve told folks that have come in here over the last year or so that our target is to take our Commercial margins up to 6% range in the next year or so and I think you are going to continue to see us marching towards that so as a take away comparing the fourth quarter of this year versus the fourth quarter of last year I think there was some noise with the acquisitions in the fourth quarter this year.

Mike McCallister

We have some major shifts going on here which makes all this relatively difficult to compare quarter over quarter because the businesses were growing in the commercial space are going to drive SG&A up and the Medicare keeps pulling it down because of the scale of locations and where that works. We’ll shed light on it every quarter but they are offsetting as we move forward.

Operator

Your next question comes from John Rex from Bear Stearns.

John Rex – Bear Stearns

If you were to take a look at your established network based in a market, let’s say Florida, and you assess the costs, what it costs you to deliver the equivalent of a traditional Medicare benefit, how does that compare, where do you fall in terms of the government program costs?

Jim Bloem

Let me try it this way, we are generally paid the equivalent of the traditional government cost on a per head basis.

John Rex – Bear Stearns

So if you strip down the benefit but your benefit is better than the government costs so now strip it down to just the equivalent to the government cost, the government benefit.

Jim Bloem

I don’t think I want to go there but I will tell you obviously we are doing better because we have a little higher overhead because of all the infrastructure necessary to coordinate care and all we do and the benefits are obviously better than the traditional Medicare program and that’s what makes this very attractive. At the end of the day I would, this goes back to my point that I make all the time we have better offerings than the traditional Medicare program period.

Over the long term our ability to coordinate it all and manage the actual costs gives us the long term sustainability and makes us part of the answer for our Federal government as they try to figure this out. Without having accomplished that then there would be no reason for us to be here. We’ve never gotten specific like that and I don’t want to do that today.

John Rex – Bear Stearns

The whole question on this business is sustainability and the issue being that on one side of the aisle is the view that it costs more for you guys do and on the other side of the aisle it costs less. You nor the industry has never done anything to show that you can deliver the costs for less. Is that something we can expect because the core here is will there be a program here in five years and if you can do it for less there will be.

Jim Murray

Perhaps we have said some things in this regard. There were some questions in quarters past on our theoretical amount that we are paid above what the Medicare fee for service and there were many percentages that were thrown out. I think we talked back then around a network based option which includes high performance networks and includes some of the utilization management programs and care coordination elements that Mike talked about. I think we talked about a target for ourselves with all these things coming together of somewhere around a 15% to 20% opportunity for us. I think that’s what you are asking.

John Rex – Bear Stearns

[Inaudible] the less developed market, I guess I’m thinking about a developed market where you have much of this in place and if you were to offer just a benefit that was only equal to the traditional program what would be your cost in that case? What I’m trying to get here is can you prove a cost savings event if you have the data to show that to defend the business model?

Jim Murray

I think I suggested that there is about a 15% to 20% savings opportunity that through various studies that we’ve done around these management programs and creating HRA’s and doing network based options or high performance networks that we think that we can be more cost effective than the Medicare fee for service environment by about 15% to 20%. I think that’s what you are asking.

John Rex – Bear Stearns

Are you saying, let me make sure I’m clear on this. Are you saying that in those developed markets where you have all this in place that you have a 15% to 20% cost advantage over the cost of a traditional Medicare benefit.

Jim Murray

I’m not trying to be coy, what I am saying is that we’ve studied all of the things that we bring to the equation, high performance network, network based opportunities, disease management programs, case management programs, personal nurses, all the things that are part of our model and we’ve studied each of those individually and as we put on a piece of paper what all those bring to the equation that’s the kind of savings opportunity we think exists. Have we ever sat down and studied Florida and compared our costs versus the fee for service world? Yes.

Michael McCallister

Your question really assumes constant health outcomes because if you just look at the original Medicare and you look at us and you look at what we do we do more things that creates the opportunity that the total cost of the government to the trust fund. It also creates opportunity for the members, because the members get better outcomes and may pay the same or less money. Those are the ways you have to take both sides in. You have to take a look at the senior savings, look at the health outcomes and then you have to look at what we are paid for what we do to develop both of those and then compare that with regular Medicare.

John Rex – Bear Stearns

It just seems that there’s somewhat of a lack of data out there in managed Medicare maybe compared to managed Medicaid that demonstrates the better efficacy the fact that the industry seems to be missing. No one is really willing to put it out there. There are obvious reasons why you might not be wanting to do that, when you think about sustainability it seems important.

Michael McCallister

I’m stunned by it. This is what we are talking about here. At the end of the day we have all sorts of clinical metrics around our industry and our company that say we do a lot better than the traditional Medicare program in terms of peoples actual health number one, so put that aside. Now the question is just economics and I think if you put the clinical is better and the economics actually work for us then you have to conclude that we are able to do that. Then there are questions if you were paid exactly what it was costing to take care of the traditional Medicare folks how would you be able to do?

That’s kind of where Jim was. There are a lot of folks at Washington that are real proud of their 3% overhead and whatever it is the traditional Medicare program I would suggest they are overpaying because there is no work being done there. The cost trends going back to 1965 would have been off the charts. That certainly is a failed model. The question then is what’s it worth to pay the private sector to manage this care and manage this program for the program? The answer is at this point we are being paid some additional funding, yes. That money is being used for two things.

To fill in gaps in an otherwise hole ridden traditional Medicare program and to put the basic infrastructure in place to management medical costs inside this program over time. The payment rates on these both for us and for the traditional program over time are likely to come much closer together. That’s the inevitability of it all. Given the fact that we think there’s 15% to 20% or 25% of fat in the Medicare program that we can get to it gives you a lot of room to run and a lot of opportunity to actually have the model play out over the long term.

That’s why we wake up every day around here relatively comfortable that there’s a long term business because this government must have somebody like us doing what we do. This is a just a question of how we get paid for that.

John Rex – Bear Stearns

One other thing on Medicare, have you assessed also the impact if one were to remove IME from the rate setting formula how that impacts your markets?

Jim Bloem

It’s not a very big impact for us and the company.

John Rex – Bear Stearns

That’s just a fact of where your membership is located, right? Number of academic medical centers and such?

Jim Bloem

Yes, that correct.

Operator

Your final question comes from Doug Simpson from Merrill Lynch.

Doug Simpson – Merrill Lynch

I was just wondering Mike, could you talk a little bit about business mix targets longer term and your thoughts on M&A with respect to diversification between Commercial and government and just give us your latest thoughts there?

Mike McCallister

Let me start with M&A, you’ve seen a couple small deals we’ve done here we talked about them today. We always look for product expansion opportunities, that’s what these represented, they are higher margin commercialized business using existing distribution capabilities and that sort of thing so nice leverage opportunities. Those are pretty obvious and we’ll continue to look at those. There are always regional plans and this sort of thing that would help us potentially with our actual foot print for commercial purposes; we don’t need it for Medicare.

Those are always on the radar screen and so we’ll stay close to that, we continue to look at things around Medicare to ask ourselves whether or not there is something close to this Medicare population that would be interesting to us. I think it’s steady as she goes from and M&A perspective, the bigger things out there you all are as familiar with them as I am and I have nothing to say about any of that today.

In terms of mix, I think we’ve been talking for several quarters now about a real continuing and growing interest and focusing Humana at the smaller end of the marketplace more so than ever. In the individual business, we like small group business; it’s still a growing market despite economic uncertainty. It’s also a place where a lot of what we are going to for consumers and prospective play out better and the smart product is where we focus.

We are trying to get real focused on those lines of business on the Commercial side that we think are interesting and not as focused on overall top line membership and basically find the right products find growing markets and then basically drive margin over time and that’s our strategy. I think that mix will continue to get better. If you look at the last three or four years it’s been a constantly improving situation for us and I think it also helps us from an SG&A perspective getting pretty focused on those lines of business that we are most interested in.

I think you’ll see more of it in the Medicare side, you are going to see more and more of our folks inside of network products for all sorts of reasons, and they are a better value I think over long term. I think you’ll see PPO and Medicare continue to grow, it’s a place where I think frankly that we have about two, two and one half year lead on everyone, just because of the heavy lifting required to build networks. I like where we are on the Medicare side, I like where the mix is moving there.

In terms of the PDP’s we’ve always been focused on the voluntary individual purchaser for that and even though memberships have been moved around and disrupted based on benchmarks and some other things auto assignees that was never our target audience. We were building products and formularies around attracting individual sales because we had a long term strategy to drive Medicare Advantage as the end product.

I think you’ll see more of the same in some ways with a great deal of focus on particular individual, small group commercial lines of business being our future.

Operator

I will now turn the call back over to Mr. McCallister for his final comments.

Mike McCallister

Thanks for joining us this morning. Let me finish by saying I think our commitment to Medicare over all these years is really been good for our company, it’s really transformed us over the last couple in particular. I still believe consumers is the long term key, we are heading more toward individual accountability and more toward individual insurance over time and I think the political winds in fact are blowing that way as well.

I think we’ll have an ’08 that should be terrific, we’ve got into some good earnings for next year, we are proud about that. Then for eight years at the end of every one of these call’s I’ve always thanked the associates that are on this call, I know there are a lot of them out there for the great work they’ve done and I’ll do it again today. We are here because as one of our candidates would say it does take a village and that’s what the Humana associates represent. With that I’ll close, thank you for being with us.

Operator

This concludes today’s conference call you may now disconnect.

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Source: Humana Inc. Q4 2007 Earnings Call Transcript
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