Health Net, Inc. Q4 2007 Earnings Call Transcript

Health Net, Inc. (HNT)

Q4 2007 Earnings Call

February 5, 2008 11:00 am ET

Executives

David Olson - Investor Relations

Jay Gellert - President and Chief Executive Officer

Joseph Capezza - Chief Financial Officer

Analyst

Charles Reidy - Citi

Josh Raskin - Lehman Brothers

Bill Georges - JP Morgan's

Matthew Borsch - Goldman Sachs

Christine Arnold - Morgan Stanley

Doug Simpson - Merrill Lynch

Greg Nersessian - Credit Suisse

Scott Fidel - Deutsche Bank

John Rex - Bear Stearns

Tom Carroll - Stifel Nicolaus

Presentation

Operator

Thank you for standing by every one. Welcome to this Health Net Inc. Fourth Quarter 2007 Year-End Conference Call. Just a quick reminder, this conference is being recorded.

Now at this is time for opening remarks, I would like to turn the call over to the Investor Relations Officer Mr. David Olson. Please go ahead sir.

David Olson – Investor Relations

Thank you very much operator. Good morning everyone.

During this call, we will make forward-looking statements that are subject to certain risks and uncertainties. Risk factors that may impact those statements and could cause actual future results to differ materially from currently expected results are described in our filings with the SEC as well as the cautionary statements in our press release issued in advance of this call.

In addition today's press release makes and the comments on this call will make reference to certain measurements that are not calculated and presented in accordance with GAAP. I should note that today's press release, which is available on the company's website, includes an income statement reconciliation for 2007 that is non-GAAP.

In addition, we included a supplemental schedule showing a breakout of reserves and healthcare costs for Capitation Provider settlements and the impact the Part D. These supplemental items provide the basis for discussion of operating metrics excluding charges, where appropriate and discussion of days claims payable excluding the costs noted above.

Let me now turn the call over to our CEO, Jay Gellert. Jay.

Jay Gellert - President and Chief Executive Officer

Thank you David, and thank you for joining us this morning. It is a pleasure to report on a solid fourth quarter and full year for Health Net. We continue to deliver results consistent with our goal. Today, I would like to review the progress we made in 2007 and highlight some key points from the fourth quarter. Then, I will turn the call over to Joe Capassa, our new CFO for an in-depth discussion of the financials.

Going into '07, we set the following goals: First, profitable growth from diverse sources. We have several opportunities for growth in each of our business line. The diversity of our business is the strength for us. It helped insulate us from changes in both the political and economic environment as we enter 2008 and 2009. Second, margin improvement, we remained focused on improving margins. Our strategic goals of growing the small end of the market, employing pricing discipline and implementing our G&A repositioning strategy provide a clear path to achieving improved margins.

Q4 showed further improvement in our commercial MCR. At Investor Day last November, we went into great detail about how our operations strategies will help expand our margins. We believe that implementing our strategy in 2008, the vision is that to be competitive going forward. We expect to bear greater cost particularly in the first quarter of 2008. As a result of implementing our operation strategy and restructuring plan, we should begin to see the positive effects in the second half of 2008.

Finally, cash generation, we had excellent cash flow in 2007. This gives us flexibility in 2008. We have a goal of repurchasing 3% to 5% of shares outstanding each year. We met that goal in 2007. It continues to be a goal for us in 2008.

Our full year 2007 results are consistent with these goals excluding the impact of charges, earnings per diluted share increased 20% for the full year 2007 compare to 2006. Total health plan enrollment increased in 2007. Our strategy of growing the smaller end of the market resulted in the addition of 73,000 individual and small group members in 2007. As expected, our large group commercial risks declined in 2007. Total commercial risks declined by 1.2% during the year, as we continue to focus on discipline pricing.

Our strategy is to grow membership profitably in the segments where we now we can compete. Our commercial success in the smaller end of the market in 2007 was the result of broader product offering and stronger relationships with our distribution channels.

Also, in June 2007, we completed the acquisition of the Guardian 50% interest in the health care solution business. We did this transaction, so we could be in control of our own destiny in the small group market by expanding the distribution of our products in the North East.

We are especially pleased with the growth in our medicare members both Medicare Advantage and Medicare Part D had excellent growth in 2007. We look forward to another year of strong membership growth in both MA and PDP. Although we did experience growth in private fee for service membership in '07 and expect to see some further growth in '08.

Our focus in Medicare is on the network business. We see that as a more sustainable and stable business especially with the changing political environment. Our January 2008 enrollment numbers for both MA and PDP are very encouraging. We had 28,000 MA members and are on target to hit our '08 guidance of 15% to 20% in MA enrollment growth.

We also had very good growth in our PDP business. As on January 1st, we have added more than 171,000 PDP members. As a result, we now expect PDP enrollment growth of 40% to 45% in '08. Our Federal Services Division had an excellent year as it continued to perform well on the north contract. In '07, we expanded our work the DoD through our behavioral health unit MHA. We expect that to continue in '08 as we introduce programs and services that meet the needs of our military service members and their families.

With regard to Medicaid, I'd like to make a few comments. We have a clear strategy in Medicaid. We want to be in Medicaid were to real manage program and were we can provide sustainable tangible value to the states. We continue to do well in Medi-Cal, the Medicaid program in California. In Connecticut we came to an agreement with the state where we'll continue to serve nearly 90,000 members on an ASO basis through March 31st of this year when we'll exit from the program.

Some costs related to this exit were absorbed in the fourth quarter of '07. I know many of you are wondering about the status of the TRICARE reprocurement process. As many of you know the release of the RFP has been imminent, since the fall of 2007. So, we could see a final version issued at any time.

We would like to highlight the DoD has done an exceptional job of soliciting and considering input from industry and other interested party during the procurement. The governments work in evaluating these comments and incorporating them into the RFP is a difficult and often lengthy process.

Finally, a brief word about Health perform in California. As many of you know, the Senate Health Committee rejected governor Schwarzenegger's effort to reform the state health care system. There are still many paths to achieve Health reforms and hope that will continue to work on a State and Federal level to achieve universal coverage.

In summary, we did some very good progress in 2007. We stabilized our commercial book while repositioning it. We have margin improvement opportunity. We have strong cash flow and we are committed to share repurchases as the use of our capital. We have the way with all to invest for the future through operations strategy and restructuring efforts. We believe that we are doing the right thing to be well positioned for 2008 and beyond.

Now, I would like to turn the call over to Joe Capezza, our new CFO. Joe.

Joseph Capezza – Chief Financial Officer

Thank you Jay and good morning everyone. It is a pleasure to be with you today for my second earnings conference call, but my first as a speaker, and the new CFO of Health Net. I have been here at Health Net for about three months now and I'm enjoying the challenges, and the opportunities and that least of all the weather that extraordinarily and my family here in Southern California.

I am especially pleased to report on another quarter of solid progress here at Health Net. From a numbers perspective, the fourth quarter and whole of 2007 have met many key targets and paved the way for continuing success in the future. I would like to start the financial review by going through the P&L. We will then move on to the balance sheet, highlight about strong 2007 cash flow and then update and refine 2008 guidance and first quarter expectations.

In the fourth quarter, diluted earnings per share rose by approximately 53% to a $1.10 per share compared to $0.72 for the fourth quarter of 2006. The fourth quarter 2006 diluted EPS was impacted by pre-tax charge of $37.1 million or $0.19 per share. Excluding this charge, the fourth quarter diluted EPS rose by approximately 21%.

The pre-tax margin was up slightly from prior periods reaching 5.5% for the quarter and 4.7% for the full year excluding charges from both periods. This is the kind of steady margin progress, we have been targeting.

Total revenue for the fourth quarter exceeded $3.5 billion as health plan premium revenue rose 11.4% compared to last year's fourth quarter. Revenues for the full year totaled $14.1 billion up 9.3% from 2006. Driving this growth with an 11.8% increase in commercial yields in the fourth quarter, helped by the effect of our Guardian transaction and our continued pricing discipline.

On the enrollment front, small group and individual enrollment climbed by more than 10% in the fourth quarter compared to the prior year period. Total commercial fully insured enrollment actually fell only 1% from the fourth quarter of 2006, as we continue to execute on our strategy to ship the mix up our business towards the small group end of the market. So this end, we have also seen the expected reductions in our large group in ASO enrollment. In fact at December 31, 2007, 35% of our commercial fully insured enrollment was in small group and individual versus 31% just 1 year earlier.

As Jay noted, Medicare enrollment was a bright spot for us. Medicare Advantage enrollment rose 18.6% in the fourth quarter of 2007, compared to the same period last year. Medicaid enrollment was up by more than 2% sequentially, but basically flat when compared to 2006. However, expected Medicaid enrollment – we expect Medicaid enrollment to fall in the second quarter as we finally exit Connecticut Medicaid at the end of March as planned, now to approximately 90,000 members.

On the cost side, commercial healthcare cost rose 11% in the fourth quarter compared to the fourth quarter of 2006. This was high because of the impact of the Guardian joint venture. While the spread between revenues and cost was positive by 80 basis points.

Let me talk briefly about the categories of commercial healthcare cost. I am willing to break them down on a reported basis and excluding the Guardian impact. We believe that excluding the Guardian impact provides a clear picture of actual underlying trends.

In the fourth quarter of 2007, versus the prior year's fourth quarter, physician costs were up by 9% and only 2% excluding the Guardian effect. Hospital costs were up 13%, but only 9% without Guardian. Lastly pharmacy costs were up 9% for the quarter, and were essentially flat excluding Guardian, due to increases in generic utilization, and lower generic costs year-over-year. We think these commercial trends are encouraging and expect a relatively stable healthcare cost environment going forward.

The overall health plan MCR of 82.6% for the quarter was 30 basis points better sequentially, excluding the charges and this is consistent with seasonal factors. However, it did increase by 90 basis points in the quarter, compared with the fourth quarter of 2006. More importantly the commercial MCR improved by 60 basis points year-over-year, and 90 basis points sequentially excluding the charges. This is further confirmation that our commercial strategy to change our business mix is driving better gross underwriting margins.

As expected we recorded our higher Medicare Advantage MCR 87% compared with last year's fourth quarter. Last year's MCR was unsustainably low due to the higher level of risk adjusted in subsidy revenue we accrued on the strength of the Part D business. For the full year the Medicare MCR was 86.3% and that’s a good number for our mix of business where we still have quite of bit of (provide) a capitation arrangements especially here in California.

We also saw the Medicaid MCR 83.4% took up slightly both sequentially and year-over-year as expected. Connecticut issues that we noted in prior calls drove much of this change.

The Federal Services business, continue to produce outstanding results on the strength of the ongoing business. Federal Services cost ratio came in just under 90% and was also helped by the ongoing expansion of behavioral health services for our men and women in uniform and their families.

Let me now turn to G&A. For the full year we achieved a 100 basis points improvement in our G&A ratio to 10.2% excluding charges. This is a good example of our increased focus on expense management. For the quarter G&A ratio also fell 100 basis points to 10.5%.

Depreciation climbed a bit sequentially and was up by $9 million for the year. We expect depreciation to increase in 2008, as we begin our operation strategy efforts and expect to accelerate depreciation on certain IT assets.

Amortization of 4.8 million was flat sequentially, but up year-over-year. This increase was due to the Guardian transaction that closed in June. We expect this $4.8 million quarterly expense level would be consistent throughout 2008.

Interest expense rose just a bit, due to slightly higher debt levels. Cash flow was very strong at 257 million for the quarter and 605 million for the full year. The fourth quarter amount included approximately $83 million in payments for the final 2006 Medicare Part D settlement and an California Medi-Cal payment that was originally due in the previous quarter. With such a strong performance, we ended the year with $275 million of cash and invested assets of the parent. This amount includes the additional $175 million and very low cost debt that we secured at the end of last year.

Before consideration of legal settlement cost related to the third quarter charge that we took in 2007, we expect to see cash flow from operations in excess of net income in 2008. First quarter 2008 cash flow will be impacted, however, via payment of $160 million of the above mentioned legal settlement costs. While we do not have a final sign of settlement as of yet, we are obligated to place this amount in an Escrow fund this quarter as we complete the final agreement.

We were active in the share repurchase in the fourth quarter, buying back approximately 353,000 shares. For the full year, we bought back approximately 4.3 million shares. We hope to resume repurchases in the very near future. We believe that this is the best use of our cash at this time.

Reserves were down sequentially just a bit, but adjusted days claims for the quarter were up by a two-tenths of a day to 54.9 days. We provide this adjusted number to give you a clear picture of reserve strength without the noise of capitation payments, provider settlements, and Part D. As we said for sometime, we expect this metric to be relatively stable, so we are very pleased with the fourth quarter number.

Let me now address some minor changes towards 2008 guidance. We are tightening the full year earnings per share range to 414 to 417 per diluted share. As we refined our view of G&A course, especially those costs related to our operation strategy effort. We are introducing the first quarter EPS number of approximately $0.67 per diluted share. We expect G&A to run high in the first quarter.

Our G&A guidance for the full year is 10%, while, we expect the first quarter G&A ratio to be approximately 10.7%. This is consistent with our guidance of Investors Day last year, but we indicated that there would be a steepest slope in earnings per share between the first and second half of the year with 38% of the earnings coming in the first two quarters. At the same time, we believe that both the commercial and overall health plan MCRs will be lower in the first quarter of 2008 than what we reported for the same period in 2007.

Let me close by saying that we've made great progress. We still have a lot of work to do. We have to continue with discipline pricing and underwriting. We have to stay focused on the cost reduction plan and we need to be nimble in our approach to market conditions. Well now, I am confident that we are up to meet these challenges and I like to meeting many more of you at the UBS Conference next week in New York and in many months ahead.

Now, let me turn it over to Q&A.

David Olson - Investor Relation

Operator, if you would start the Q&A queue we would appreciate it.

Question-and-Answer Session

Operator

Thank you very much sir. (Operator Instructions). And we will take the first question from Charles Reidy with Citi.

Charles Reidy

Thanks, good morning. I just want to ask more about the first quarter guidance for $0.67 and you know, what is the level of additional SG&A spend or other unusual items we will be spending in the quarter. And also whether you plan to take a charge, I think you implied in your Investor Conference related to some of the SG&A investments that you would be making?

Jay Gellert

Charles its Jay.

Charles Reidy

Okay.

Jay Gellert

How are you?

Charles Reidy

Good.

Jay Gellert

Let me first address the issue of the SG&A effect. As we indicated in the release, we anticipate SG&A is about 10.7% in the first quarter. To get to the 10% guidance, which we have is round about 9.75, 9.8 on average for the rest of the year. So that differential is the SG&A effect in the first quarter related to restructuring of strategy and some of the thing we had earlier talked about. It includes all of the costs except for severance and retirement of assets. We anticipate that will come in at about $6 to $10 million in Q1. So that's kind of it. Everything other than that, duplicate staff, the consulting, all of that related to our strategy, all is included in the $0.67 guidance.

Charles Reidy

I see. So the first quarter SG&A on an ongoing basis, we should think about is really being more like 9.75 or in line with the rest of the year average, if we were to exclude those items that relate to these initiatives.

Jay Gellert

Combination of that and that will begin to get some saving in the second half of the year from some of the efforts in the first quarter/

Charles Reidy

And in the fourth quarter, can you quantify for us, there is a benefit from the lower tax rate. You still hit the $10 to what extent was their additional discretionary SG&A spend versus other necessary spend items. I am just wondering if the tax rate were more in line, would that have been mess in the quarter.

Jay Gellert

There are three things, that I think speak to that one is there was some additional G&A related to the up strategy that was absorbed in Q4. In addition, as we indicated, we had cost related to exiting the Connecticut Medicaid, that were included in the Q4 numbers as well as some truing up of risk adjustors as it relates to Medicare.

Charles Reidy

Got it. And just finally the new Medicare Advantage ads, can you say roughly what percent were private-fee-for-service versus PPO and HMO?

Jay Gellert

The vast majority were HMO.

Charles Reidy

Great. Okay thanks.

Joseph Capezza

And Charles the ratio that we were referring to was the G&A ratio, not the SG&A ratio.

Charles Reidy

Got it. Thank you.

Operator

We will next take a question from Matthew Borsch of Goldman Sachs.

Matthew Borsch

Hi. Good Morning. I wanted to touch on a question. I know it's come up repeatedly, but just trying to understand from an outsider's perspective why you appear to not be more proactive in may be exploring a sale of the company. And If I can just mention a couple of factors that come to mind is that in that context is that first it seems that you have been below scale in most of the North-East region excluding, I suppose Fairfield County, Connecticut for a long time. And the second is relatively extensive East-West systems consolidation project, what seem in a certain sense to be money wasted in the event a sale does occur. If you could just readdress, and then I've just got one much more specific follow up question?

Jay Gellert

I think that the issues you have raised will be successfully addressed through the up strategy we are talking about.

Matthew Borsch

Okay. I understand, it sound like that you have a good payoff from you know projected from the investment that you are making, you know on the other hand, you know the other way of looking at that, if the company were to be sold then that wouldn’t be necessary in the first place and presumably those saving could be realized without the investment.

Jay Gellert

I thought Goldman was doing fairly well and did not need a lot more investment banking business.

Matthew Borsch

Okay. Better go on to the next one. Can you talk about the outlook or the results in California Medicaid, because I know there have been issues in Connecticut, but may be just bring us up-to-date on where you are there and what the outlook is?

Joseph Capezza

Well the results for the year have been stable and we are comfortable as we look into '08 with the continued stability of the result.

Matthew Borsch

And what about the impact from the or potential impact you should say from the Governor's proposed budget. Would that just be a pass-through in your view?

Joseph Capezza

We have to get a better view of kind of where that lands. We have kind of gone with this process virtually every year of people talking about potential impact. I don't think we have good enough light of sight, but it won't fundamentally disrupt our business in any way.

Matthew Borsch

And then I just like to slip one last question here. You know any discussion underway about your leverage, debt leverage is kind of at the low end of where your comparable companies are. You may be potentially stepping up the level of share repurchase. You will be on the 3 to 5% that you've targeted?

Joseph Capezza

That's our target and we are staying with it at this time.

Matthew Borsch

All right. Thank you.

Operator

We'll next take a question from Josh Raskin of Lehman Brothers.

Josh Raskin

Hi, Thanks, good morning. Two questions from my end. First, if you could just run through Joe, maybe the investment income assumptions that you're using in terms of rate you're sort of expecting throughout the year? And then the second question on seasonality regarding the first quarter earnings, I'm just curious how much impact or if there is additional impact from the PDP membership obviously, you guys are growing that significantly next year and a lot of matures. So I was just curious if that was also causing a little bit more of the lower first quarter number?

Joseph Capezza

Okay. With regards to the investment, our market value yield to maturity is in the 4.5% range, our average coupons in the 4.8% range, and the duration of our portfolio is only a little over 3 years. And with regard to the second question, it will have some effect in Q1 also and it's another issue that affects Q1.

Josh Raskin

It doesn't sound like Jay then that's a significant difference than what you were saying, it seems like SG&A is the big driver?

Jay Gellert

Yeah. G&A is the big driver and I think it's the Q1 effect versus the rest of the year. It's had some effect, but it's more the G&A spend as we indicated at Investor Day.

Josh Raskin

Okay. And I'm sorry Joe, just on the first point. Are you assuming those are -- did that yields maturity and coupon remain steady throughout the year or do you have assumptions in terms of changes there?

Joseph Capezza

Yeah. With this current market it's tough to judge what's going to happen to the market value yield to maturity. But I think we are well positioned to take advantage of potentially the climbing interest rates as we the effect continue to ease up on their position.

Josh Raskin

Got you. And then just last quick question. Medicaid MCR in 2008, we just assume you're going to see a little bit of benefit there with the exit of Connecticut.

Joseph Capezza

Yes.

Josh Raskin

Okay. Thank you.

Operator

Well, next move to JP Morgan's Bill Georges.

Bill Georges

Thanks, good morning. My first question is around your TRICARE loss ratio in the quarter, much better than what you've historically reported. Can you just sort of give us some of the drivers there and then how should we think about that when we are forecasting that segment in '08?

Jay Gellert

It's the result of some positive experience on the Mental Health program as well as some continued benefit on the healthcare side. We don't anticipate it and haven't built it into our expectations for '08. And so I think we should stay with the guidance we had for '08 in terms of that program.

Bill Georges

And, when is really to drop that did on getting an extension in that program. I mean it has to be soon. Is it something that we could expect in the next couple of weeks or are we going to see rolling extensions on a monthly basis as you've mentioned there has been a possibility before?

Jay Gellert

Yes. There are two issues. One is the timeframe of the reprocurement and the other is the extension. They are not necessarily related because even as reprocurement drags so that it can't be completed by the dated question, doesn't necessarily mean an extension will be immediately forthcoming? In (statute) there is a 10-month transition period for the new contract. And so in theory a word would have to be made by I guess May 31^st in order for that contractual requirement to be met. That's very hard to see with no RFP at, that's virtually impossible. So I think, there will be extensions, when exactly they are forthcoming in the contractual process is unknown.

Bill Georges

Okay. And just one last quick one. You did mention that you still saw avenues for California Healthcare Reform. You are much closer to this situation, I think than we are. It seems to me from what we have read in the papers though that everything that is going on out there with the Governor's proposal is dead. Is there still the possibility that it could be revived?

Jay Gellert

The Governor has said that he intends to continue to pursue it. It's hard to see an initiative get on the ballet in '08 given the timing. But we are in a situation where we have term limit measure on the ballet today in fact in California. If it doesn't pass there'll be changes in structural leadership in the legislature and that conceivably could lead to some different approaches that the Governor is considering.

Bill Georges

Okay, great. Thank you.

Operator

We'll next take a question from Christine Arnold of Morgan Stanley.

Christine Arnold

Hey there. A couple of questions; first on the change in '08 guidance, was there any change kind of your enrollment assumptions or any of your lost ratio assumptions or is all of the change owing to the change in G&A?

Joseph Capezza

There are some changes in enrollment between Medicare in commercial, but they are the minimus. They are kind of irrelevant. It’s the only effect of G&A.

Christine Arnold

Okay. And then as we think about cost trends, it looks like relative to what you were thinking or seeing last quarter, the drug trend came down a little bit. And the doctor trend looked really muted, but it looks like the hospital might have up ticked. Could you talk about what you are seeing in terms of hospital pricing as you enter '08 and your expectations with respect to volumes.

Jay Gellert

I think our hospitals expectations all in as we enter '08 are in the high single digits. It’s the combination of unit cost; some outpatient unit increases; we're not seeing an inpatient trend.

Christine Arnold

So the high single-digit hospital trend is driven by outpatient?

Jay Gellert

Some outpatient utilization, but primarily unit cost and both outpatient and inpatient.

Christine Arnold

And are unit cost rising year-over-year?

Jay Gellert

Unit costs, yes.

Christine Arnold

Accelerating?

Jay Gellert

No, they are staying pretty consistent.

Christine Arnold

Okay so that's pretty stable?

Joseph Capezza

Yeah they are not coming down, but they are not going up.

Christine Arnold

And then final question is some of your competitor's kind of got (rid) of some of these PDP members. Has your view of PDP profitability changed now that you are seeing how many of these dose, you are getting in and starting to see some of the drug claims?

Jay Gellert

No.

Christine Arnold

Recognizing it early?

Jay Gellert

No.

Christine Arnold

Okay. Thank you.

Operator

We'll next move to Doug Simpson of Merrill Lynch.

Doug Simpson

Hey good morning. You guys have been adding individual small groups at a pretty good clip and just looking at the numbers in the release also looks that the churn in that book has been decent running something around 10% if I'm looking at the California numbers. And I would think that both of those would help your commercial MLR this year. So I'm trying to look forward to next year and understand what are your expectations for enrollment growth in that book of business and what should we be thinking about what the MLR on that piece of business as it matures. How do you manage that churn aspect of it?

Jay Gellert

We're being more conservative in our expectations for growth due to a combination of the softening economy and in certain places the few competitiveness issue. We really want to keep focus on the issue of pricing discipline. So, we're expecting less favorable growth pattern. We could be surprised, but we are building in this expectation, so that we can take consideration of the economy and in fact some of the statements that some people have made. It will continue to see growth, but it won't be as strong as we based on our expectation as it has been in the last year.

Doug Simpson

Okay. And there is no concern, or you are not worried at all about the churn dynamic and the aging of the book. I guess one thing would be helpful, do you have the average age of your individual and small group contacts this year versus where they were a year ago or maybe two years ago?

Jay Gellert

Yes we can get that for you. We have been monitoring it and we feel good about it but we can get you the detail.

Doug Simpson

Okay. And then just if I could just ask you….

Jay Gellert

Doug I know I'm two years older than I was two years ago.

Doug Simpson

Just stepping back it looks you guys have obviously added I think 10.5% the number and in some markets it’s even been higher, I mean what you know, New York, California you guys are obviously growing up very rapidly. What’s the reason for that? I mean just your networks I wouldn’t think are that much, you know, you probably don’t have an advantage over some of the larger players. The brand you are competing against, the bigger names. Then why are you showing such robust growth in that area.

Jay Gellert

Well, there are two important points when you look at those numbers. One is while we are growing double digits the number isn’t huge when you put it against the size of those markets. So as a result we don’t have to compete head on with the “market leader big named” in order to move that kind of membership. It’s more a result of very focussed strategy on building relationships with distribution. It is the result of pricing stability and there has been some more erratic pricing by some of our competitors in these markets, which causes disruption, and third some focus product offering. We have talked a lot about our focus in the Latino market we have focused on some other market opportunities. And again when you look at the sheer number versus the sizes of the market the effective execution is the key to our success, not putting ourselves in a position where we have to be “price competitive” with any other leaders you articulated.

Doug Simpson

Okay. All right, thank you.

Operator

We will next move to Scott Fidel of Deutsche Bank.

Scott Fidel

Thanks. First question just onto the Medicaid, exit, and can you give us what the annualized revenue is from Connecticut Medicaid as we think about adjusting the models for that exit after 1Q.

Jay Gellert

It is about $180 million bucks. And the important point to note is that it went to ASO in December 2007, so we had actually one less month of risk business in 2007. The other point to note too which relates to some of the, I guess, “exit clauses” typically of the three months in the last quarter, December is the lightest month, so we ended up picking up the two heavy months and not the light month.

Scott Fidel

Okay. Just on the MA growth, may be if you could you know help us think about I wish most of it in the network-based products but how that is trending out between snipped products and then sort of the standard Medi-Cal network-based products?

Jay Gellert

The vast majority of it is the standard networks-based products.

Scott Fidel

Okay. And then can you update us on just expectations for all end commercial pricing yield and medical cost trend for 2008?

Joseph Capezza

We are staying with the guidance we gave at Investor Day, which was 8% commercial yields and commercial healthcare cost trend 30 to 50 bips better than yield.

Scott Fidel

Okay. And then just one last question on sort of looking at the balance of the lower interest rates from the Fed, and sort of how do you view the offset between, investment income and interest expense? Do you think they sort of netting out to equal or do you think there could be some modest pressure from the lowest interest rate environment?

Jay Gellert

Sorry, could you repeat that.

Scott Fidel

Just in terms of the lower interest rates, you know you've got potentially pressure on investment income but opportunities on interest expense and sort of how do you see the two of those offsetting each other?

Jay Gellert

We think it is going to be relatively stable between the two. Right now investment income we are expecting is about $110 million for the year in 2008, interest expense up slightly to about $34 million. And depending what happens with the variability of the interest rates on the expense, so I believe we might see a little savings there.

Scott Fidel

Okay. Thank you.

Operator

We'll move next to John Rex of Bear Stearns.

John Rex

Thanks. Just back to the G&A in the first half, your Investor Day you said $15 to 20 million if you call above the line reorganization cost you are going bear during the year. What is that number now? And in case give us how you are modelling this now in terms of the fall?

Jay Gellert

The number we gave you was a net number. Actually the costs in the first half the year above the line are greater than that. And so the difference in the G&A that we have talked about, which is you know, the 10.7 and then lower but not to the 9 -- above 10 in the second quarter and then lower numbers in the second half of the year. That kind of reflects the distribution of that across the quarters.

John Rex

So, okay, I didn't realize it was a net number when you gave me 4, so is 15 to 20 million still the net number or is it higher now?

Jay Gellert

We've probably built, probably when you look at the range change we made, we probably have given ourselves you know, a little more available resource to get this done, because it looks as though we can get it done a little quicker.

John Rex

Okay. And then on TRICARE again, we look at 63 million in gross profit in the Q it was 80 percent up over last year, 30-some percent over last quarter. So, is there a component of that that’s due to settlements of prior periods, something that we should think about as one time.

Jay Gellert

Yeah, I think that there are some issues with regard to kind of how the experience basically settled out, that led us to those kinds of numbers. It is also some of the mental health issues with the kind of payment process on the mental health issues. We are not changing our guidance for next year from the guidance we gave regarding TRICARE. And so that gateway you should look at it.

John Rex

But it doesn’t sound like, you are not necessarily characterizing those as one time though, it sounds like.

Jay Gellert

I guess when you ask one time, one of the key things is, there are three or four one time things that are moving in different directions. So you have some things that are non-recurring on the TRICARE side. At the same time, you don't have any kind of recurring costs from the Medicaid exit in Connecticut and some of the true up on the other side in terms of Medicare. So when you package all those, I put them together and basically say they didn't move the earnings.

John Rex

Okay. And then it sounds like you are still guiding to about 30 to 50 basis points of commercial MCR improvement in '08, in terms of the way you characterize premium yield and cost churns, should it even be a little more than that if your book of business is still shifting more heavily to individual and small group though? I mean would we expect it to be better than the 30 to 50 basis point that we actually see?

Jay Gellert

Because of some of the assumptions we've made on the economy, and some of the conservatism we've kind of built in because of the anticipation potentially of some efforts on the part of some of the competitors, we'll see less transition in the model we're building '08 off of than we did in '07. So we're not counting on the degree of shift large to small that we saw in '07 again in '08. And so as a result, the change we are talking about is as much driven by same store pricing as it is by the shift in the book, we've seen in earlier years.

John Rex

Okay. And I take it your commentary on membership earlier would also indicate you, you indicated at one time that January would kind of be the first time in the years that you saw up commercial membership. Is that not your expectation any more. Is that correct?

Joseph Capezza

Yeah, we're up in all the markets except the northeast, and that basically brings us to the point where we are about flat.

John Rex

Okay. Thank you.

Operator

We will next move to Greg Nersessian of Credit Suisse.

Greg Nersessian

Hi, good morning. Just a follow up on that last question, so the northeast I guess with the in sourcing of the Guardian, when should we expect to see some sequential growth in the northeast, in the commercial business. Also you are not happy in one, one, is that going to flow through in the back half of the year or should we be waiting for '09.

Jay Gellert

I think we are looking for a more like stability in the back half of the year and the growth would begin in '09.

Greg Nersessian

Okay, that's helpful. And then another question, just on the commercial book, was there any material amount of prior period reserved development in the fourth quarter intra year? I saw the prior year number was basically flat, but is there anything intra year?

Jay Gellert

It is not a significant amount, it is at the minimus amount.

Greg Nersessian

Okay, that's helpful. And then just a couple of more quick ones, the all in cost trend and yield I think you answered on the previous question was about 8%, does that include the Guardian, or is that the ex-Guardian?

Jay Gellert

The all in.

Greg Nersessian

That's the all in. What is the ex-Guardian yield?

Joseph Capezza

We will have to get that for you, I don't think we have it right here, but we'll get it for you.

Greg Nersessian

Okay, that's fine. And then finally, could you just tell us what the Medicare MCR was again and did you see that was up sequentially.

Joseph Capezza

Yeah it was up the fourth quarter Medicare MCR was up 100 bip sequentially and came in at about 87.

Greg Nersessian

Okay. What was the driver of this sequential increase, was that people come in out of the donut hole?

Joseph Capezza

I am sorry. I was talking about MA, I wasn’t talking about PDP.

Greg Nersessian

Okay. That’s fair. Okay, that’s was it. Thank you.

Operator

(Operator Instructions). We'll next move to Tom Carroll of Stifel Nicolaus.

Tom Carroll

Good morning. Quick question on Connecticut Medicaid. Your comments certainly imply, you continue to plan to exit the market, but Wellpoint has hinted out a possible compromise with the sate. If Wellpoint reaches an agreement would you guys rethink your exit in that market?

Jay Gellert

We wish them well.

Tom Carroll

Okay. That’s pretty direct. Thank you very much.

Operator

(Operator Instructions). And it appears, we have no further questions coming in at this point.

Jay Gellert

Thank you very much operator. We will see all of you down the road. And we'll be reporting first quarter that was in late April, we'll give you an exact date shortly. Thank you again for joining the call this morning. Good bye.

Operator

That does conclude this Health Net Inc. Fourth Quarter 2007 Earnings Conference. We thank you all for joining us and have a wonderful day.

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