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Aetna, Inc. (NYSE:AET)

Q1 FY08 Earnings Call

April 24, 2008, 08:30 AM ET

Executives

Jeffrey A. Chaffkin - VP of IR

Joseph M. Zubretsky - EVP and CFO

Mark T. Bertolini - President

Analysts

Carl McDonald - CIBC World Markets Corp.

Michael Baker - Raymond James

Matthew Borsch - Goldman Sachs

William Georges - JPMorgan Securities, Inc.

Christine Arnold - Morgan Stanley

John Rex - Bear Stearns

Peter Costa - FTN Midwest Securities

Justin Lake - UBS Securities

Doug Simpson - Merrill Lynch

Greg Nersessian - Credit Suisse First Boston

Operator

Good day and welcome to the Aetna's First Quarter 2008 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeff Chaffkin. Please go ahead sir.

Jeffrey A. Chaffkin - Vice President of Investor Relations

Good morning and thank you for joining in this first quarter 2008 earnings call and webcast. This is Jeff Chaffkin, Head of Investor Relations for Aetna and with me this morning are Aetna's Chairman and CEO, Ron Williams, and Joe Zubretsky, Executive Vice President and Chief Financial Officer. Following their prepared remarks, we will pleased to respond to your questions. Joining us for the Q&A portion of this call is Mark Berotolini, President and Head of Business Operations.

During the call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently expected results are described in Aetna's 2007 10-K, filed with the SEC. Pursuant to SEC's Regulation G, we have provided reconciliations of metrics relating to the company's performance that are non-GAAP measures in our first quarter 2008 press release, first quarter 2008 financial supplement and our guidance summary. These reconciliations are available on the Investor Information portion of the aetna.com website.

Also as you know, Regulation FD limits admissibility to respond to certain enquiries from investors and analysts in non-public forums. So Aetna invites you to ask all questions of a material nature on this call.

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

C: Ronald A. Williams:Chairman and Chief Executive Officer:Good morning and thank you Jeff and thank you all for joining us this morning. Earlier this morning, we reported operating earnings per share of $0.92 for the first quarter of 2008. An increase of 14% compared to the first quarter of 2007. This result is in line with our prior guidance and we're very pleased with our performance, given the highly competitive marketplace and the emergence of a challenging economic environment.

Our solid results are based on the effective execution of our strategy, which continues to advance our success as demonstrated by our strong and well-diversified revenue and membership growth in the first quarter. In addition, we had strong underwriting results primarily from disciplined pricing actions. Our focus on managing healthcare quality and total costs and good medical cost experience, which continues to be in line with our expectations. We also continue to achieve operating expense efficiencies and our disciplined capital deployment initiatives yielded positive results. Joe will provide more detail regarding our results later in the call.

I now want to highlight several strategic initiatives that continue to differentiate Aetna in the marketplace and position us for long-term profitable growth. Then I will provide an update regarding our integrated value proposition and the associated success we are seeing from it in the marketplace. Very specifically, Bank of America's decision to select Aetna as its provider of choice.

We believe this win will launch the next generation of fully integrated product solutions for our industry and Aetna is clearly positioned as a leader in this respect. With regard to our strategic initiatives, our segmentation strategy continues to be successful in the marketplace, by delivering products and services that are meeting the varying needs of our customers and identifying opportunities to enter new markets. We delivered net medical membership growth of 614,000 members this quarter, bringing our total medical membership to 17.5 million as of March 31st.

Our national accounts, government, middle market, global and individual customer market segments all posted solid commercial membership gains and we also had very strong growth in Medicare. This result demonstrates the value of our diversified product offerings and distribution capabilities. As a result of our strong medical membership growth this quarter, we now project full year net medical membership growth in the range of 850,000 to 900,000 members. This represents an increase of 50,000 from our prior guidance.

We also continue to expand geographically. This quarter for example, we successfully launched our individual product in five new states expanding our offering to a total of thirty markets. By providing products specifically designed for individuals and their families, we continue to create workable solutions for various segments of the uninsured population. In addition to the strong medical membership growth this quarter, dental membership grew by 334,000 members and pharmacy grew by 219,000 members.

We continue to focus on consumerism and the quality in total cost of healthcare. Our consumer-directed health plan membership grew by 365,000 members this quarter, bringing the total to 1.4 million members at March 31st. Additionally, we are now offering the Aetna Health Fund HRA to small group customers, which further differentiates Aetna in the market and solidifies our leadership position in consumer-directed healthcare.

Also this quarter, as part of our continued commitment to total employee health and wellness, we announced that our disease management services are now available to our international members, making Aetna the first expatriate benefit carrier to offer a comprehensive disease management program. We also continue to focus on operational excellence as a key component of our strategy.

Our commercial medical benefit ratio was 79.8%, in line with our prior guidance for the first quarter. This reflects strong underwriting discipline and medical cost management. Additionally, our underlying operating expense efficiency continued to improve. While our reported operating expense ratio for the first quarter was 18%, it was 17.5% when adjusted for acquisitions, a 50-basis point improvement year-over-year.

So why are Aetna's results and outlook different from some competitors? One answer is that our systems and technology which are an integral part of both the way we view and do our business, makes us different. Let me give you two examples. The first differentiator is the single integrated information portal we utilize and which by the way is continually being updated and improved.

This portal, which we call EMIS, allows for real-time review of information containing critical business results. More specifically, it provides us with an interactive tool to view key metrics that can then be viewed independently, comparatively or trended over a period of time enabling quick analysis, drill down capabilities and more effective decision making.

A second essential element of our technology is the part that helps us create value for our customers and members. And you've heard me discuss this too, but it bears repeating. Through our proprietary active healthcare engine, the clinical database which is an increasingly integral part of our business, we are able to deliver information that helps customers better manage quality and total costs. When combined with our broad array of technology tools for members that provide information about wellness, clinical quality, evidence-based care guidelines and other critical data, you essentially have, what I call our integrated proposition.

This is a significant advantage because the integration of our products and services help control costs for customers and improve healthcare quality for our members. We believe, this is resonating in the marketplace as evidenced by the recently announced Bank of America win.

As announced earlier this month, Bank of America has chosen Aetna as a primary provider for a broad range of benefits. This will include medical, dental, behavioral health, disease management, life and disability for active and eligible U.S-based associates and expatriates. Effective January 1st of 2009, Aetna will provide benefits to more than 350,000 Bank of America members. This represents a major expansion of our current Bank of America relationship, which currently consists of approximately 130,000 medical members and less than 100,000 dental members. It is important to point out that the bank challenge health insurers with a progressive new benefits model that calls for unprecedented levels of integration. Aetna met that challenge.

As a result we will provide Bank of America with an integrated solution, designed to engage members in their healthcare, improved satisfaction, simplify the service experience and improve quality and total costs through disciplined tracking and measurement. Our clinical benefits expertise care engine technology, comprehensive database of health information and extensive national network of providers were are all contributing factors to their success. We believe our selection is a validation of the significant value that Aetna's integration strategy provides to the marketplace. Our approach demonstrates how Aetna is leading the industry and has laid a solid foundation for differentiation and for continued strong performance for the balance of 2008 and beyond.

In closing, we continue to expect 2008 to be another year of solid membership increases and strong earnings per share growth, based on disciplined pricing and medical management, operating efficiency and effective capital deployment. We remain confident in our 2008 operating earnings per share guidance of $4 and we are committed to making the appropriate investments in people, processes and technology to deliver a differentiated brand experience to our constituents and to sustain our growth rate over the long term.

We are also mindful of the changing political and economic environment and believe our flexible operating model positions us well to respond to them. I would like thank our talented and dedicated employees for their continued dedication and diligence in supporting this quarter's solid performance, and their unwavering focus on executing on our profitable growth strategy.

Now I will turn the call over to Joe Zubretsky, who will discuss our financial performance for the first quarter in more detail and provide additional insights into our outlook for the reminder of 2008. Joe?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Thank you, Ron and good morning. Earlier this morning, we reported after-tax operating earnings of $469.6 million for the first quarter of 2008 or $0.92 per diluted common share. This represents year-over-year increases of 8% and 14% respectively. Our first quarter 2008 after-tax operating earnings included $461.6 million in earnings from healthcare, a year-over-year increase of 9%, $34.9 million from group insurance, which is 12% higher than the prior year quarter, $8.5 million from large case pensions, a decrease of 7% year-over-year and $35.4 million in corporate interest expense compared to $27.5 million in the first quarter of 2007.

Aetna's first quarter results include the impact of our Schaller Anderson and Goodhealth Worldwide acquisitions, which closed in the third and fourth quarters of 2007 respectively. For the first quarter of 2008 these acquisitions did not have a material impact on our operating earnings or net income. As I analyze our financial results, I will note whether inclusion of these acquisitions impacted the operating metrics.

Our net income for the first quarter of $431.6 million included $38 million of the after-tax realized capital losses. This was driven primarily by the accounting for certain fixed income investments which decreased in market value due to the widening of credit spreads and the resulting increase in yields. For the first quarter of 2008, our diluted weighted average share count was $509.1 million, a 5% decrease from the prior year quarter due to share repurchase activity.

Turning now to the key drivers of our financial performance, let me first address our operating margin for the first quarter of 2008 and its key components, revenue, healthcare cost trend and operating expenses. In the first quarter, our pre-tax operating margin was 10.3% which represents $801.2 million of pre-tax operating earnings. The decrease in margin percentage from the prior year was in line with our expectations and driven primarily by Medicare mix as well as a modest impact from our recent acquisitions. These results continue to demonstrate management discipline across all aspects of our business, including pricing rigor, healthcare quality and total cost of management and operating expense control.

We continue to execute our strategy for profitable growth as evidenced by the strong top-line growth we achieved this quarter. As a result of solid membership increases, disciplined pricing actions and contributions from acquired businesses, revenue increased 16% in the first quarter from $6.7 billion in 2007 to $7.8 billion in 2008. Healthcare segment revenue increased 20% year-over-year or 17% excluding the impact of acquisitions.

Premiums in our healthcare segment increased 21% year-over-year or 19% excluding the impact of acquisitions. Our first quarter commercial premiums increased 8% over 2007. This resulted from 3.5% volume growth and a yield increase of 5.5% partially offset by a 1% decline from the effective product mix.

Our premium growth continues to be driven by expansion in our Medicare products. Medicare premiums increased 88% compared to the first quarter of last year and our Medicare advantage membership is 97% higher than the year ago quarter. The drivers of this increase in Medicare premium included the conversion of approximately 100,000 members from AFC to a fully insured group private fee for service product as well as solid growth in our individual Medicare Advantage and PDP offerings.

First quarter consolidated fees and other revenue of $825.3 million increased 13% over the prior year quarter or 5% excluding the impact of acquisitions, driven primarily by volume growth. Turning to our healthcare cost experience in the first quarter, our commercial medical benefit ratio was 79.8% in the quarter, 20 basis points higher than the first quarter 2007 ratio of 79.6% in line with our prior guidance.

Our Medicare medical benefit ratio was 86% in the quarter, compared to 88% in the year ago quarter also in line with our expectations. True-ups of premium estimates contributed to this 200 basis point improvement while underlying medical cost experience was in line with our expectations. Our Medicaid medical benefit ratio was 92.8% this quarter, higher than our expectations due to catastrophic claims and higher than expected medical costs on one of our risk contracts. Our total medical benefit ratio which includes commercial, Medicare and Medicaid products was 81.3% in the first quarter of 2008 compared to 80.7% in the prior year quarter.

Finally with respect to medical cost in the first quarter; medical cost trend was in line with expectations by component and in the aggregate, as we recently described at our investor conference. Prior period reserve development was not significant and days claims payable were 44.4 days a slight increase of 0.2 days sequentially and the flu season had an approximate $10 million pre-tax incremental impact on first quarter medical costs, which are fully reflected in our results. These favorable results reflect our continued commitment to enhancing quality and managing total costs through our rigorous medical management processes, as well as our continued ability to maintain pricing in line with medical cost trend.

Our solid group insurance results are worthy of a few comments. These products are a key component of our fully integrated product strategy and the Bank of America win is testimony to that. Specifically, group insurance premiums declined 4% year-over-year. This was primarily due to the lapses of accounts that were not meeting our profit margin targets. Additionally, continued pricing discipline and improved disability results contributed to the 610 basis point improvement in our benefit ratio, year-over-year. The third key component of operating margin results is operating expense efficiency. We continue to leverage our infrastructure this quarter by growing revenue in core markets and products, driving down unit costs with technology and business process improvements all while investing for future profitable growth.

We achieved an operating expense ratio of 18% consistent with the prior year quarter. Excluding our recent acquisitions however, our operating expense ratio of this quarter was 17.5%, representing a 50 basis point improvement. The second driver for our financial performance is investing for profitable growth. During the quarter we grew medical membership by 614,000 members bringing our total membership to 17.5 million at March 31st. As a reminder, our results this quarter reflect the conversion of a large case with approximately 100,000 members from a commercial ASC product to a Medicare insured product.

The numbers I will now discuss will be reported membership growth which includes the effect of this conversion. Sequentially, commercial growth was 445,000 medical members, Medicare growth was 157,000 members and Medicaid grew by 12,000 members. Our commercial insured medical membership growth was sequentially flat this quarter, reflecting continued pricing discipline in a competitive environment, adherence to strict underwriting guidelines in what we believe to be a cyclical preference from the larger middle market customers to shift from insured to ASC arrangements. We achieved strong growth in both insured and ASC membership during the first quarter. Of the 614,000 members we added, 162,000 were insured members and 452,000 were ASC members.

Virtually all of our customer market segments experienced growth. Specifically we had strong growth in our national account customer market segment, driven by new customer wins and strong opening open enrollment gains, partially offset by some in group attrition reflecting a slowing economy. Our middle market customer segment had a strong quarter adding over 30,000 members although our success was concentrated in the higher end of the market, which tends to prefer ASC arrangements to insured product offerings.

We also saw balanced growth in our government customer market segment coming from state and local municipalities, school districts as well as hospitals. In addition, we had a meaningful growth in our individual and global benefits customer market segments. The majority of our global benefits membership growth was driven by a recent win of a large international defense contractor which added over 40,000 members. Our individual products had another strong quarter adding 24,000 members due to successful market penetration in key states including Colorado, California, Texas and Florida as well as the implementation of the AARP relationship. And finally our membership growth was diversified geographically, with five of our six regions experiencing growth during the first quarter.

The third and final area of financial performance I will comment on is our management of capital and its accretive deployment. This includes our cash flow dynamics, our holding company liquidity, how we deploy that liquidity in the quarter and our capital structure.

Our first quarter 2008 GAAP operating cash flow for healthcare and group insurance was $960.6 million representing 224% of GAAP net income. This was due to primarily to the timing of tax payments and a deposit from one large customer. However, we continue to expect our operating cash flow as a percent of GAAP net income for the full year to be approximately 130%.

During the first quarter, we generated approximately $331 million of holding company cash flow. We also issued $273 million of commercial paper. This resulted in approximately $600 million being available for deployment which we used to repurchase 12.8 million of our shares. We accelerated the pace of share buyback program this quarter to take advantage of current market conditions. Our basic share count was 485 million shares at March 31st down from 496 million at December 31st.

Our capital position continues to be strong with a debt to total capitalization ratio of approximately 26%. Despite difficult market conditions during the first quarter, we successfully expanded our bank facility from $1 billion to $1.5 billion and extended its term to 2013. We also subsequently expanded our commercial paper program by an equivalent amount which further enhances Aetna's financial flexibility and liquidity profile. As I had previously stated. our strategy included moving our total capital structure to 30% debt to capitalization including hybrid securities. We'll look to issue both debt and hybrid securities when market conditions are favorable. Our recent annual rating agency meetings included a discussion target capital structure and the initial feedback we received on this topic was favorable.

In light of the recent turmoil in the credit markets, I would like to update you on our investment risk and return profile. Our overall portfolio quality continues to be very high. Our holdings are well diversified across assets classes and durationally matched. Our assets class profile is consistent with that shared with you at our investor conference.

As noted earlier we did have $38 million of the after tax realized capital losses this quarter. It is important to note that this is driven by the accounting for certain fixed income investments which decreased in market value, due to the widening of credit spreads and the resulting increase in yields in 2008. Our overall debt and equity portfolio shows a net pre-tax unrealized gain of $66 million as of March 31st, which was a $209 million gain at December 31, 2007, a solid portfolio position. The noteworthy impact of the current credit environment continues to be the prospects for lower investment income due to the continuing decline in interest rates. Our 2008 guidance includes our current interest rate expectations for the year.

Before we move to the Q&A session, I would like to provide some additional guidance for 2008. Given another quarter of solid financial and operational performance, we have confidence in our ability to sustain our momentum for the remainder of 2008. We will monitor the slowing economy and the resulting lower interest rate environment and continue to reflect the impact of these external factors in our planning assumptions for net membership growth, realized premium yields, utilization trends and net investment income. Based on this, for the full year 2008 we now project medical membership growth to be in the range of 850,000 to 900,000members, up 50,000 from our prior expectation and we continue to expect approximately 40% of our membership growth to be from insured arrangements as previously communicated at our investor conference.

We also project at least 15% healthcare revenue growth, medical cost trend of 7.5% plus or minus 50 basis points, a premium yield that is in line with medical cost trend, a commercial medical benefit ratio of less than 80% with a total medical benefit ratio of below 81.5% and operating expense ratio showing an approximate 50 basis point improvement year-over-year. A pre-tax operating margin that is lower than 2007 primarily due to the above average growth in Medicare, particularly group private fee for service and operating earnings per share of $4 or growth of approximately 15%.

The operating earnings per share estimate is based on a fully diluted weighted average share count that is likely to be lower than the $505 million that we previously projected. But the final average share count will be dependant on market conditions.

However, any favorable accretion we may obtain due to share repurchase activity could be offset by lower investment income. For the second quarter of 2008, we expect the commercial medical benefit ratio to be less than or equal to last year's second quarter ratio of 80.5% and operating earnings per share to be $0.93, a 12% increase over prior year.

In summary, I am very pleased with first quarter results along all three dimensions of our financial performance. Managing to our target margins, investing in profitable growth and accretive capital deployment. We are well positioned for continued profitable growth in 2008 and I am confident in our ability to achieve a level of financial performance we have projected. With that I will turn the call back over to Jeff, Jeff?

Jeffrey A. Chaffkin - Vice President of Investor Relations

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

Question And Answer

Operator

Our first question comes from Carl McDonald from Oppenheimer & Co.

Carl McDonald - CIBC World Markets Corp.

Could you walk us from the same-store pricing yield of 7.5% in the commercial risk business down to the reported commercial yield increase which I think was about 2.8% in the quarter and any impact of acquisitions the mix shift that you mentioned, other factors?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Sure Carl, the yield that you're calculating for financial statements, we actually have a calculation of slightly higher but you are in the ball park. It's really the effect of mix as we said many times, the products that have lower price points are growing at faster rates in our core commercial book and that is the yield that you are observing in the financial statements; really the effect of product mix.

Carl McDonald - CIBC World Markets Corp.

Okay so that accounts for basically all of that difference?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Yes.

Carl McDonald - CIBC World Markets Corp.

Okay. And then the second question is how much of an investment income hit that you absorbed in the quarter. So said a little differently. If interest rate environment were the same this year as it had been last year what would have been the positive effect to the reported earnings and the related question is just to clarify your current guidance of $4 it assumes interest rates at the current level as opposed to assuming interest rate continue to deteriorate?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Yes, the first question I think the key points would be if you look at the financial supplement you'll observe that investment income for the healthcare sector was basically flat quarter-over-quarter. So didn't contribute to growth and earnings at all. You'd expect it to be up with the investible base up but with the yield drift, it actually was flat. In the group business it was actually lower by $14 million in the first quarter of 2008 over the first quarter of 2007. So we have very, very good group results despite a $14 million decrement to investment income. Your second question. We generally forecast our interest rates that are consistent with the yield curve when we book our quarter. So whatever the forward look... whatever the spot rates are embedded in the yield curve is the way we forecasted interest rates.

Operator

Our next question comes from Michael Baker, with Raymond James.

Michael Baker - Raymond James

Yes. I was wondering if you could provide us with some color on BofA's decision not to include the pharmacy piece in light of their progressive stance on integration. My guess is it's just a function of relative scale there and then secondly it seems as though on the PBM side there has been a pick-up... recent pick-up in competitive dynamics. I am wondering if that has any impact on your ability to integrate pharmacy in the '09 selling season.

C: Ronald A. Williams:Yes, good morning Michael. Let me first say that we are very pleased with the Bank of America win. It was a very affirming win from our point of view because, the win really focused on the value of our integration strategy and I think the bank held a highly competitive process in which the... we believe the leading firms in the country had participated in from our point view we though that the bank selecting us was very positive and we think did it really reflects the beginning of what we think will be a trend of companies really looking to extract the full value of the integration value proposition for their employees and to manage their medical cost strength. I'll ask Mark to respond to your question on the PBM component.

Mark T. Bertolini - President

Sure, thanks Ron. Michael on the PBM component; the bank has had a long standing relationship with Caremark and that relationship has been of a high service level for their employees. Our integration proposition through them, carried various levels of trend opportunity based on the level of data integration that we had and while we won't get complete data integration like we had proposed with our own PBM, we will get a sizable opportunity for Bank of America by maintaining the Caremark relationship and we do integrate data with them today but not at the highest level that we came with our own PBM. On the competitive marketplace, we continue to grow our PBM, we continue to gain penetration into the book of business and as demonstrated by the BofA account not all of our national accounts move over but we continue to gain penetration in that segment.

Michael Baker - Raymond James

Thanks.

Operator

Our next question comes from Matthew Borsch from Goldman Sachs.

Matthew Borsch - Goldman Sachs

Yes, good morning, thank you. I am just wondering if you could elaborate just a little bit more on the dynamic you referred to as cyclical preference for self insuring amongst employers and why that maybe picking up now and where you see that going? Thanks.

C: Ronald A. Williams:Yes, Mark will respond to that.

Mark T. Bertolini - President

Matt, we actually took a look over an extended period of time the last five to seven years to look at the trend of employers moving between risk and self funding. In that analysis, we have seen in the national account segment, a continued movement away from risk relationships. However, that has been balanced by the government sector continuing to look at new opportunities like Medicare private fee for service and so overall in our book we've seen actually maintenance of the risk ASC, shift in the national accounts segment.

Obviously, small group of middle market remains a risk environment but at the high end of middle market and what we would call the key accounts area; accounts between 300 and 3000, what we have seen is a cyclical nature where employers move in and out of risk relationships. Depending on the underlying trend in the marketplace and their view about the underlying risk of their own population and they move back and forth between risk and ASC and it's been a very constant trend over in the last five to seven years based on that and usually what happens; our groups move into ASC. They will get a reinsurance contract both specific in reinsurance contracts. They will have some significant cases. The rates will change and then move back into the risk environment.

Matthew Borsch - Goldman Sachs

And just one follow up. On your enrollment growth outlook for the remainder of this year looks like sort of mid point a little bit above 250,000. Do you mean that 40% of that would be insured in any sense of how it'll break down between commercial and other?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Matt, the guidance we've given you of 850,000 to 900,000 when you look at those two totals approximately 40% of that result will be risk membership and 60% will be non-risk membership and the reason we feel comfortable with that nine month projection is if you recall, last year we put on 460,000 members in the last nine months of year. 250,000 or so, which were risk. So we have really good visibility on these off peak membership businesses that we conduct. Small group, individual, student, etcetera and we feel very comfortable with the estimate.

Matthew Borsch - Goldman Sachs

Great, thank you.

Operator

Our next question comes from Scott Fidel from Deutsche Bank.

C: Ronald A. Williams:Scott, if you're speaking we can't hear you.

Operator:Scott. Please go ahead.

A: Scott Fidel: Deutsche Bank:Yes, hi. Can you here me?

C: Ronald A. Williams:Yes now we can.

A: Scott Fidel:Sorry about that my headset. Just wondering if you can walk through the components of medical cost trend and how they changed sequentially. Then also give us an update on how your initial claims experience in the group private fee for service conversion is trending so far?

C: Ronald A. Williams:Okay. Joe will answer.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Well, Scott I think the medical cost trend component we described that our investor day are still holding. Our inpatient trend is mid to high single-digit, outpatient low double-digit, physician low to mid single-digit and pharmacy high single-digit and really nothing has changed either in the aggregate or in its components.

A: Scott Fidel:And then around the initial experience of the group TFF account.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

It's very early. We're very happy with account it's performing according to expectations, but it's still really early. The good news there and we've to take stock in this is it is a new account. Recall that we were managing these 100,000 lives on an ASC basis in prior years. So we've excellent visibility into the medical cost utilization trends and the utilization patterns of that population. So we're feeling really good early on.

A: Scott Fidel:And Joe, just a quick follow up on the balance sheet. Looks like there was a sequential change in the assets and liabilities of the separate account line and maybe if you could just us provide some color on the change there?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

On the separate accounts... you're talking about the separate account assets and liabilities Scott?

A: Scott Fidel:Yes.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

We transferred a large separate account to the investment manager that were managing the assets and we're no longer responsible for managing that account.

A: Scott Fidel:Okay.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

There is no... no effect on the income statement whatsoever.

A: Scott Fidel:Okay. Thank you.

Operator:Joshua Raskin from Lehman Brothers has our next question.

A:Joshua Raskin: Lehman Brothers:Thank you. Good morning. Just want to talk a little bit about the outlook for 2009.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

What about my headset [ph].

C: Ronald A. Williams:I guess we're still getting Scott's headset.

A:Joshua Raskin: You guys can hear me okay?

C: Ronald A. Williams:Yes. We can hear you fine Josh.

A:Joshua Raskin: Okay, great. I will tell Scott to take his headset off. The ASO accounts, obviously, Bank of America is a big chunk in terms of growth for next year. So I am just curious what you are seeing in terms of the outlook and the momentum, some of your other competitors have reported that some service issues etcetera. So I know it's early but, I don't know if Mark have got some comments on what he is seeing in terms of RFP activity final rounds, are you guys doing a little bit better etcetera.

C: Ronald A. Williams:Yes, I would say that the process is building at this point Josh and what we're seeing is there is a lot of activity. I think it's early but I will ask Mark to give you a little more color on it. I think in the context of the competitive environment, what we are seeing is that when we win, we are winning in the market by virtue of the value that we bring... both the information technology and systems that we have, the very consistent and high quality service, the long term and persistent investments we've made in our strategy really are the things, that I here over and over again when I spend time with our customers. But Mark can give you the specifics around that.

Mark T. Bertolini - President

Joshua RFPs continue to be up. I think in our last call we talked about in the early look, and there were maybe 15, 20 RFPs out that we saw larger accounts coming out with more significant opportunities like Bank of America. And we continue to gain share of those wins as we forward 2009. We're now seeing the rest of the pipeline fill for 2009 and it continues to be robust. It is a competitive marketplace, but as a result of the BofA announcement and some conversations we have had with folks we have a lot of interest in that model and are very focused internally on building an industrial strength capability to support that model going forward. So, so far so good.

A:Joshua Raskin: Okay, that's helpful. And then just a quick question on the Medicare side of the book, sort of touching on the last question, how comfortable are you in terms of your trends there, I think Joe had mentioned some sort of true-ups that took the MLR down there by couple of 100 basis points. So curious that if we get a little bit more color on that, and just were there any benefits designed changes, any big program changes or anything like that, other than that, one large conversion on the Medicare side, just to reconcile what we think maybe the potential is there for changes in cost terms.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Josh the true-ups are reference that the normal process of chewing up your risk adjustors in terms of the revenue reconciliations with CMS and nothing unusual there and with respect to program changes, the 100,000 conversion is really the new factor that's driving significant premium growth, we did add, as you know 27,000 or 28,000 individual MA numbers but product design is pretty much consistent with prior years and there is nothing unusual in the in force.

C: Ronald A. Williams: Yes probably the one thing I would add is that, when we looked at our data last year we did see some trends in terms of the richer benefit plans and so our data systems permitted us to identify and we positioned our Medicare individual products for 2008, anticipating the dynamics that we saw and I think that's helped us a lot in 2008.

Mark T. Bertolini - President

We also saw that in the high end of the prescription drug program last year we re-positioned our high benefit drugs and PDP so as there was shift in the first part of this year based on where people's pricing came in we think we did well in attracting the kind of risks that we could manage.

A:Joshua Raskin: Right, thanks.

Operator

Our next question comes from Bill Georges from JPMorgan.

William Georges - JPMorgan Securities, Inc.

Thanks good morning. I am wondering if you could give us a little bit of color around what you are seeing in terms of the pricing environment both ongoing in 2008 and then what's your early look into 2009 and maybe if you could specifically break out any sort of behavioral difference between the... your public competitors and your private and non-profit competitors?

C: Ronald A. Williams:Yes a good morning Bill I think I would start of by saying that this is a competitive marketplace, it has been a competitive marketplace, the dynamics will vary both by customer segment and geography and I think generally what we are seeing is consistent with what we described at the investor conference, Mark would you provide it?

Mark T. Bertolini - President

Sure on the... it all of course it all happens market-by-market and segment-by-segment and so we're very involved in managing the pricing dynamics in each market by segment vis-à-vis our competitors. So I would say in the main we have not seen any substantive change in the competitive pricing environment worsening or getting better than the last year. We have not seen in the public company competitors any substantive changes of yet in their pricing relative to products based on their reported results. And in the not-for-profit sector, we have started to see some changing in the pricing of those not-for-profit competitors as reserve issues, I had them in investment income issues of them but we have not seen a whole sale movement yet but we're starting to see the early signs of it within your filings.

William Georges - JPMorgan Securities, Inc.

Is it fair to say some of the key not-for-profit players then are shoring up their pricing, is it the key ones or is it some of the smaller ones, can you help us with that?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

It's some key ones but not all them.

William Georges - JPMorgan Securities, Inc.

Okay, and could you update us on your views in terms of M&A does anything look more attractive to you in the current market given the current conditions and stock prices?

C: Ronald A. Williams:Well, I think the main thing from our point of you is really our strategy and I think we have a very active pipeline, we're just as active today as we have been looking at really things that will help us from the advantage point medical management, cost and quality helping us with the ability to innovate and meet customer needs and lot of our acquisitions have been focused on capability and skill building to meet our customers. And then the third area is clearly continuing to increase our local market density. So the answer is the strategy remains the same we're very active in what we look at and that's pretty much be how we think about it.

William Georges - JPMorgan Securities, Inc.

Okay, great thank you.

Operator

Our next question comes from Christine Arnold from Morgan Stanley.

Christine Arnold - Morgan Stanley

Couple of questions here. You characterized RFP volume as robust. Could you be more specific in terms of, are you seeing more accounts of yours in kind of out to bid or less versus last year and more or less in terms of number of accounts and size of accounts incoming?

And then could you comment on hospital pricing. Many of your competitors have had a challenge with hospital pricing, what are you seeing with respect to hospital pricing in '08 versus '07 and I know you've changed the structures of some of your contracts, excluding that, seeing that change in structure would there have been a change in hospital pricing?

C: Ronald A. Williams:Okay, Christine on the RFP volume I would say that we're seeing about what we expected from our own book of business. I am going out to bid, there are no surprises. It is less than what we are seeing come out the market from the standpoint of other companies. But in the end analysis I mean and all that, it's all wash out, it's all about what you win or what you keep, not necessarily about what goes to bid.

On the hospital front and the hospital pricing environment we are at our expectations for hospital pricing by market, we have a model that, continues to monitor our pricing expectations and our pricing results versus what we've forecast in our operating plan. I would say it's difficult to tease out the change in the contracting model and its impact had we not done it, because the nature of the negotiations change by virtual of how we contract. But over all the pricing environment is stable for us. We have about 15% of our contracts still open for 2008, and less than the third of our contracts open for 2009 as we go into in the...good line of sight into the value of our contracts going into the remainder of this year and next year.

Christine Arnold - Morgan Stanley

And ex-BofA, is your RFP volume coming in more or less than it was this time last year?

C: Ronald A. Williams:More.

Christine Arnold - Morgan Stanley

More in five, more in number, more in both?

C: Ronald A. Williams:More numbers of accounts the size of all this, all depended on how much they are for whether or not, your offered as one of many carriers or you get a whole replacement.

Christine Arnold - Morgan Stanley

Okay, thank you.

Operator

We will now go to John Rex, with Bear Stearns.

John Rex - Bear Stearns

Thanks, a question also on hospitals, coming utilization couple of other competitors have mentioned, slightly higher utilization and particularly on the coast, on the West Coast I've heard commentary about rising, NICU utilization, just wondering if you are seeing anything in the hospital on the utilization side that looks unusual?

C: Ronald A. Williams:Good morning, John, the answer is no, what we are seeing is flat, utilization there are always some variations within particular cases, but nothing that we would view as a change in the fundamental trend that we see.

John Rex - Bear Stearns

Okay great, I could just get a clarification on the lower share count that you incorporated in the guidance, kind of can you give us an order of magnitude, how we think about less than $505 million.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

John, it's really difficult to say as you know the primary use of our capital is to finance organic growth, the secondary use is to fund acquisitions and obviously the default is repurchase shares. So we generally don't forecast how many shares we're going to repurchase at what price. How many options to get exercised and how corporate liquidity that will observe. So we're just sort of getting a leading indicator that if we did continue a share repurchase activity it could be lower than $505 million, but given the softness of investment income that could easily be absorbed by lower investment income later in the year. I'd model it at $505 million.

John Rex - Bear Stearns

Okay. And would that be fair to say that can of your current model in terms of how you've looked about declining interest rates and such is very close to $505 million at the movement in terms of what you've baked in for declining interest rate?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Yes, we are comfortable with the $4 per share at $505 million and our investment income forecast which considers the current yield curve position.

John Rex - Bear Stearns

Great. Thank you.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

You're welcome.

Operator

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

Peter Costa - FTN Midwest Securities

Hi, can you talk a little bit about the Medicare group business and what you see changing there is that accelerating when your competitors talk about they believe that might be accelerated next year and then in particular. Since you have a lot of experience with that now with your large account there do you believe you will be able to use that to leverage in to get more commercial business as well?

C: Ronald A. Williams:Yes, good morning Peter. The fact I would remind you of is that we have this relationship with HRPA, which is the Human Resource Policy Association which is composed of the top 250 leading corporations in America, that relationship really siners around the group Medicare product as well as a health access product for pre-Medicare retirees, that's been a very important sponsorship in terms of giving us access to clients in increasing awareness along with the success that we had this year and Mark and the team have actually been conducting some workshops in forms with employers and he can tell you on what's going on.

Mark T. Bertolini - President

Sure, Peter. On the Medicare group, we think about it in three ways, one is in the government sector, the GASB value proposition that we have offered to governmental employers in trying to size their GASB liability and limit that liability going forward they have to report, has been a very important event for us and that's one of these large accounts that we got for January 1 was based on that model.

Governmental accounts take a while to mature and once you start getting a few of them they start talking to one another and gains momentum in the sector and we are seeing an increase in the interest on the part of the governmental sector in our Medicare private fee for service product for their populations. On across the United States there is $1.6 trillion in unfunded liability for governmental agencies related to their retiree health benefits. So we think that's a fairly large market.

When we move from there we move to companies where we have been administering, there is supplemental retirement benefits in coordination with Medicare in the commercial sector. We have well over a million members in that sector that we are talking to all of those clients about the value of moving to a Medicare group product. And so that's a fertile ground for us in addition to the HRPA relationship with 250 of the nation's largest employers.

And then we started to move down middle market as we've honed the value proposition and the product offering, for more packaged offering in the middle market for employers that are either looking for solutions for retirees where they don't offer coverage or where they do offer coverage or want to offer coverage and we can cover the benefits for them.

Peter Costa - FTN Midwest Securities

Thank you.

Operator

Our next question comes from Justin Lake with UBS.

Justin Lake - UBS Securities

Thanks, My first question just on the commercial risk membership side, you mentioned in-group attrition, which has been kind of brought up in few other calls as well as the ASO conversions, can you exclusively give us those numbers as far as what you are seeing from for in-group attrition for that to begin first quarter as well ASO conversions, and maybe compare them and give us the numbers for 2007.

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

Justin, we are not going to give that level of detail on this conference call you it is a factor, we have factored it into our membership projection for the balance of the year given the slowing economy, but we are not going to disclose sort of the ins and outs of our large business.

C: Ronald A. Williams: Yes, I'd probably also remind you that the account reclasses where accounts move from risk to ASC which was described earlier in some ways mass effect that we are still seeing robust commercial resale's in the marketplace. And so it really is the account reclass that suppresses that number little bit.

Justin Lake - UBS Securities

Yes, I guess that's what I was trying to get Ron, understanding with the actual membership growth is in commercial rates at some of these moving parts, that are more macro related than business momentum?

C: Ronald A. Williams:Yes, I think the simplest way to provide yourself some additional perspective on that is to think about that 100 possibly 100,000 Medicare risk member which would have been basically in essence a commercial account when we were administering the supplement plant.

Justin Lake - UBS Securities

Okay, and then just a quick question on SG&A, Joe I think you spent some time at the investor day, highlighting all of the investments, that you're making there as far as from a dollar standpoint, just wondering if you can highlight two or three where you, two or three places where your spending money, where you think kind of the next growth opportunities around come from?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

I think it's a consistent with the strategic rational you previously talked about we continued to invest in opening new markets in individual and Medicare business which requires media launches. We continue to invest in our operating platforms, our pharmacy platform, our individual and Medicare platforms unifying our macro platforms into a unified system. We just continue to spend on all those fronts.

And as I said at our investor day, the result we produced in the first quarter is consistent with the strategy in that two-thirds of the SG&A growth that otherwise would have been represented by volume has been offset, we have actual cost reductions and leverage of our fixed cost structure which accounted from the 50 basis point declined quarter-over-quarter adjusted for acquisitions so the first quarter result is very-very consistent with the macro strategy.

Justin Lake - UBS Securities

Great, thank you very much.

Operator

We'll now go to Douglas Simpson from Merrill Lynch.

Doug Simpson - Merrill Lynch

Hi, good morning. Ron I was just wondering if you give us a little perspective giving your background on just the potential for the changing regulatory clinical back drop next year and just how are you spending your time day-to-day, any differently if at all. Is it more just to wait and see and I know its hard to get specific because we don't now how things are going to play out but I'm just trying to think how dos that factor in your into your thought process looking out over the next year or two.

C: Ronald A. Williams:Well, I think it is an important factor we spend a lot of time working on, I would break into elements, one is a good deal of time spend in Washington working with both policy staff and Congressman and Senators and a strong focus on the Senate in particular to understand the issues, the concerns, the policy positions and really try to be a company that is contributing to parts of the solution there for example we've been a big supporter of Senator Kennedy's mental health parity bill, it's a bill that we think is well constructed and can do something good for our members but also has the right features that give us the ability to manage well on behalf of our customers.

In the broader context I think that we have to get beyond the political component of this and move into the real policy aspect. So we are really positioning ourselves very strongly for the policy. The second issue is really focusing, very much at the state level, I spend some time, Mark spends a lot of time focused on the state level, working with governors and various state legislators, we have really a very good, state affairs area that is very focused on trying to figure to out, what it is states want to do and how do we help them do that in a way, that is not disruptive to the marketplace and really helps them accomplish what they want to do.

Our view is that, we'll get through the election, the formation of a new administration and that whatever happens, will really begin to come in the focus late '09 early '10.

Doug Simpson - Merrill Lynch

Okay, great thank you.

Operator

And we have time for one more question and that question comes from Greg Nersessian from Credit Suisse.

Greg Nersessian - Credit Suisse First Boston

Hey thanks, good morning just a couple of quick ones, one the Medicare advantage enrollment growth I am sorry if you have mentioned this already, but did you update your expectation for 2008?

Joseph M. Zubretsky - Executive Vice President and Chief Financial Officer

I think the projection for 2008 will be flat with the first quarter results so we are not looking for any in your membership growth in Medicare advantage.

Greg Nersessian - Credit Suisse First Boston

Okay, great and then just the final one, wondering if you could talk to a couple of new business opportunities one being the Connecticut medicate program that I'm seeing you are bidding on, maybe you just talk a little bit about what's different about the Connecticut Medicaid programs, you understand it going forward then the, sort of troubled program with the past?

And then secondly any comment on the Tricare RFP, if your view on bidding on that business has changed with that RFP on that?

C: Ronald A. Williams:Okay Mark will speak to the Medicaid program and then I'll address for Tricare.

Mark T. Bertolini - President

Sure, Greg. On the Medicaid program we're involved in the RFP response. I think what's different about the program that has been in the past is number one, the addition of the Charter Oak program, which is an expansion of Medicaid and SCHIP for people who can't otherwise afford healthcare services. We have taken a very careful look at the experience, the underlying provider rates, which were impacted by recent legislation and are obviously pricing this to what we believe, would be an appropriate underwriting margins to manage the business effectively.

C: Ronald A. Williams: Yes in terms of the Tricare program the RFP as you all know is out we've been anxiously awaiting it we're evaluating it very carefully, trying to understand all the new launches there were 400 questions that have been posted by potential bidders seeking clarification and we expect that we will continue to evaluate it and reach conclusions about the course of action. We view it as attractive potential segment for us, when we'll apply our same underwriting and financial discipline to pursuit of this segment as we have to other segments.

Greg Nersessian - Credit Suisse First Boston

Okay. That's helpful. Thank you.

Operator

And that's all the time we've for questions. I'd like to turn the conference back over to our presenters for any additional or closing remarks.

C: Ronald A. Williams:Thanks Jeff. The transcript of the prepared portion of this call will be posted shortly on the investor information section of the Aetna website at aetna.com. If you have any questions about matters discussed this morning, please feel free to call me or one of my colleagues in the Investor Relations office. Thank you again for joining us this morning.

Operator

This concludes today's presentation. Thank you for your participation and have a wonderful day.

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Source: Aetna, Inc. Q1 2008 Earnings Call Transcript
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