Executives
Drew Asher - Senior Vice President, Corporate Finance
Dale B. Wolf - Chief Executive Officer
Shawn M. Guertin – Executive Vice President and Chief Financial Officer
Analysts
Josh Raskin - Lehman Brothers
Justin Lake - UBS
Scott Fidel - Deutsche Bank
Matthew Borsch - Goldman Sachs
Carl McDonald - Oppenheimer
Charles Boorady - Citi
Matthew Perry - Wachovia
Doug Simpson - Merrill Lynch
John Rex - JP Morgan
Michael Baker - Raymond James
Coventry Health Care, Inc. (CVH) Guidance Call June 18, 2008 5:30 PM ET
Operator
Welcome to Coventry Health Care’s conference call. (Operator Instructions) Today’s call will begin with opening remarks by the Chief Executive Officer of Coventry Health Care, Dale Wolf, after a brief forward-looking statement read by Drew Asher.
Drew Asher
Ladies and gentlemen, during this call we will make forward-looking statements. Certain risks and uncertainties as described in the company’s filings with the SEC on Form 10-K for the year ended December 31, 2007 and Coventry’s Form 10-Q for the quarter ended March 31, 2008 may materially impact those statements and could cause actual future results to differ materially from those anticipated and discussed.
Dale B. Wolf
To say we’re disappointed with the news we shared earlier this afternoon is an understatement. I believe we do understand the drivers quite well and we will be able to articulate those to you. I am going to turn it over to Shawn immediately and then wrap up with a few comments at the end, including our plans to deal with some of these issues.
Shawn M. Guertin
I’ll set up my comments related to our Medicare private fee for service business. The issue here to a large extent starts and ends with the fact that the lag in claims submission on this product is substantially longer than we had assumed at the end of 2007, and for that matter substantially longer than what we experience on our Medicare Advantage HMO business.
By no means do I intend to minimize the issue or my disappointment in the outcome, but it’s important to understand that at its heart, this is more an issue about reserving an internal operation than it is about core product fundamentals.
Having said that, this is an area where we have historically performed very well and we should have done much better than we did. To no surprise, a part of the issue here has to do with better education and coordination with both providers and members. Let me give you an example of what I mean here.
We’ve discovered that too many times, our members go to a provider and present their traditional Medicare card as opposed to their Coventry Private Fee for Service card. This creates a chain of events whereby the provider incorrectly submits the claim to the Medicare fiscal intermediary. The Medicare fiscal intermediary rejects the claim and tells the provider this member is covered by an MA plan.
Providers have told us that this can take 30 to 60 days to get this notice. To make matters worse, this notice doesn’t tell the provider which MA plan the member is covered by, and then the provider has to track down the member, get the correct information and only then finally submit the claim to us for processing.
In total, issues like this can add months, as opposed to days, to the claims submission and processing timeline. Member and provider education is an area we have worked on since the inception of the product, but clearly an area we will need to continue to work on going forward.
In the spirit of full disclosure, we have also found a number of things that we could do better as well. Not entirely surprising for a new product, but over the past few weeks, we have discovered some issues regarding our own processing that were not only creating delays in the claim payment process, but also creating some gaps in our analytics around understanding the true claim lag on this product. Needless to say, we have already moved to put these fixes in place.
Let me now turn to the financial details behind this issue. The first implication of this is that we expect to experience $50 million of unfavorable reserve development in 2008 that is related to calendar year 2007, the majority of which developed in the first two months of the second quarter.
The second implication of this is that since 2007 now appears $50 million worse than we previously expected, the run rate medical loss ratio coming into 2008 is higher than we had previously assumed. As a result of these two factors, our outlook for the 2008 GAAP MLR on private fee-for service is up approximately 600 basis points from prior guidance.
This result, when combined with our Medicare Advantage HMO business where our MLR outlook is unchanged from prior guidance, results in the total Medicare Advantage MLR being up 300 to 340 basis points from prior guidance, expecting this to settle out between 85.5% and 85.9% for full year 2008.
I’d like to give you a bit more insight into the run rates on Medicare Advantage going forward. As mentioned previously, we expect the combined Medicare Advantage MLR for 2008 to be between 85.5% and 85.9% on a reported basis.
If you back the $50 million of unfavorable development out of the current year, you’d get a loss ratio a little over 84% as the run rate going forward. Within this run rate, you would see that the HMO business is performing in the low 80s and the private fee for service business is performing in the high 80s. Finally, it’s important to keep in mind that private fee for service is still a fundamentally sound and profitable product at this loss ratio level.
Let me now turn to the Commercial MLR story and start by stepping back to the first quarter of 2008. As of the end of the first quarter, our reserve development on Commercial was right on track with our expectations in prior years, so there did not appeared to be any problem related to 2007.
Our best real time indicators of cost levels, inpatient days and pharmacy expense showed no signs of any systemic problems. We had fully reconciled what was going on with premium yield mix and could see that our pricing was operating as intended. In short, all credible indicators that you could look at appeared fine.
The story has developed in a different direction with the April and May results and particularly with the insight they now provide us on Q1 expense levels. The punch line here is that we are seeing higher than expected medical cost levels related to Q1 2008 dates of service. As a result of the observed higher cost levels, we are now estimating that our trend outlook in commercial MLR will increase by 150 basis points from our previous guidance.
So how is this playing out? To no surprise, as we observed in the first quarter, inpatient utilization and pharmacy expense are fine. Physician expense appears fine as well. However, we are seeing higher than expected trend levels in outpatient utilization and inpatient unit costs, both areas where we had fairly limited visibility at the end of Q1.
Let me try and give you a little more insight as to what we’re seeing here. Starting with outpatient utilization, you might recall that we were modeling a decrease of 100 basis points in this category in our 2008 trend outlook. Well, instead of a decrease, we are seeing an increase of about 300 basis points in this category, creating a swing of about 400 basis points.
On about 25% of the total expense, this is contributing about 100 basis points to the 150 basis point loss ratio increase we are now estimating. Digging into this more, we are seeing particular pressure in the areas of ER visits, chemotherapy and radiology.
On inpatient unit costs, trend levels appear to be about 200 basis points higher than expected. Again, on about 25% of the total, this makes up the remaining 50 basis points of the 150 basis point increase in the loss ratio. This does not appear to be due to some unexpected change in our provider contracts, but rather due to an increase in the severity of claims experienced in the first quarter. We have clearly experienced more high dollar claims in the first quarter than we experienced a year ago.
One of the first things you think of when you see something like this is whether you have some new business that is causing the problem. That is not the case here. We looked at the experience in our recent new business and it is performing consistent with our expectations. As an aside, this review also corroborated for us that nothing was broken in our new business pricing process. So this is an area where we can see the effects fairly clearly, but are still studying in detail to determine all of the causes.
Even though we have not determined all of the causes, we are not sitting on the sidelines waiting to take action. In our guidance, we have not assumed any improvement in these trend levels for the balance of the year. In addition, we have already taken pricing action in response to this. Back in March when many of the industry earnings announcements first came out, we implemented a 100 basis point increase in our trend factors, that at that time we viewed as more opportunistic than necessary.
The timing of that change was such that it will have a smaller impact in 2008, but captured a very large proportion of the 2009 renewals. In addition, given the most recent developments we are working on a second wave of price increases as we speak.
At the end of the day, these two items really tell the story. We have updated all the other elements of our guidance and the story here is that a lower outlook on the other operating items is fully offset by an improved outlook on the non-operating items. The decrease in outlook on these other operating items was driven mainly by lower expectations on commercial risk membership growth, as well as a lower fee revenue projection in our workers’ compensation services business.
The improved outlook on non-operating items is driven mainly by an improved view on share count, driven by the repurchases to date, as well as planned repurchases for the balance of the year.
Again, by no means do I intend to minimize these two issues, nor can I express the level of my disappointment related to these two developments. In fact, both of these are in areas that are near and dear to me personally.
Having said that, I believe we have taken the prudent approach here to prevent these items from being a drag in the future and get us back on track for EPS growth in 2009 and beyond.
This concludes my remarks, and before we open up the call to questions, I’ll turn it back over to Dale for some additional comments.
Dale B. Wolf
Hopefully you’re fairly clear on the facts behind our adjustments today. Here is my take on each of these issues. First, on private fee, there is really nothing here about the performance of the business or its prospects. It is performing even after these adjustments at a level at or better than our pricing assumptions. It is simply not as good as we thought it was, and we didn’t know that till now due to the elongated claims patterns as Shawn has outlined.
On the commercial business, the business is not performing as well as it did last year in addition, to as well as our expectations. While unfortunate, it does happen in this business, and we are pleased that it has nothing to do pricing, risk selection or competition. As we mentioned, corrective pricing action has been initiated and there is more to come as we ascertain the longevity and direction of the spike.
So in terms of what we are doing about it, three things need to happen here. One, we need to improve the timeliness of our claim recognition on private fee. We have and will work more on the external piece, but there is a limited ability to influence the perfection of the ID card process among beneficiaries and providers. And we will fix the internal piece. Second, we will adjust commercial pricing. As we said, some has done, more to follow. And third, given these developments, we need to further strengthen our management of our own G&A within the company.
Just before this call, we implemented actions across the company in both the staffing and non-salary areas to further tighten our already leading cost positions. Overall, we take the need for immediate corrective actions very seriously, and we believe we have acted as such. Fundamentally, however, let me be clear. Our businesses are sound; our market positions are strong, and executions remain solid. We remain optimistic for the future.
I will now open the call to questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Josh Raskin - Lehman Brothers.
Josh Raskin - Lehman Brothers
On the sources of the cost drivers, the outpatient utilization and then the inpatient unit costs, I’m just curious you said you have lower visibility in the first quarter on that. What’s the claims lag and do you not have hospitals? Because it feels like in the past you knew about the big cases that were coming on.
Dale B. Wolf
The latter one, Josh, is part of what has made this difficult. We actually do track large cases and where we’re seeing these high dollar cases is in a quarter of claims between 50,000 and $150,000 paid. We typically track jumbo claims higher than that. And that’s our typical process.
And actually, the odd thing about this is those jumbo claims certainly aren’t trending as this one cohort is. This one cohort we are seeing just much higher claim level. So it did not show up “in the true jumbo claims”. It was a level down, if you will. And again just the normal claims cycling you didn’t see all that.
Josh Raskin - Lehman Brothers
So it was just below the big, big problem issue, that you look at. Second question, just why are the hospitals, just commentary from a lot of the hospital companies, they’re just not seeing these volumes in the second quarter. So, it sounds like they’re not talking about higher acuity cases. Again, I’m curious how you reconcile that.
Dale B. Wolf
Well, I can’t fully reconcile the acuity. I can certainly reconcile the volume because we’re not seeing a volume problem at all. The days, in-patient days are very consistent with our expectations, and frankly consistent with prior years. So from a pure volume standpoint, I think those do reconcile. But I can’t, I just, I can’t fully reconcile, if you believe there’s a general belief that there was not some acuity spike broadly, why we’ve seen that. But that type of commentary would be the first time that the hospital said something and we experienced something different. But I just wanted to be clear; we are not seeing a utilization problem on inpatient.
Josh Raskin - Lehman Brothers
Medicare obviously, the bids were due part in the filings, can you just remind us, just the timing, did you have the ability to change your benefit guides and your counties and all that stuff? Did you file for any of that or was this uncovered in the last week and a half here?
Dale B. Wolf
The full severity of it was only uncovered in the last few weeks. Now, we did have the benefit when the bids went in, of at least seeing April. And so out of that $50, explicitly we built in around $25 million of unfavorable development. Now, we do a few other things to hopefully buy ourselves some room in that bid, but I would say from this issue alone, as it stands today, we didn’t capture all of that.
Now, keep that in context. This is a line of business that’s probably being between $1.5 and $2 billion this year, and that, the full $25 works out to something like a point of profitability. I would also point out there is still a lot to play out in the year in terms of revenue and all of those things. There is a lot of moving parts here, but if I just put this in isolation, I would say we missed about $25 million of it.
Operator
Your next question comes from Justin Lake - UBS.
Justin Lake - UBS
Are there any geographies where you saw these higher costs be more intense than in others?
Shawn M. Guertin
There are a few geographies, for example, where there have been severity spikes: Utah, Central Illinois, Atlanta stick out. Again, it’s harder because from time to time we do see acuity spikes in market to market, but the total sum of these was still a spike. So we definitely saw that there certainly the rates are different by plan, but I would say that some of these outpatient drivers, it’s fairly consistent of being a driver across the book.
Justin Lake - UBS
If you were to think about now I assume you probably got some visibility at this point through, maybe you could tell us where do you have visibility through on these higher costs on the outpatient side and the severity?
Dale B. Wolf
Well, we have two months run out on the first quarter. So I think we had enough visibility to make a call here and do that. But I think that’s about it and I would tell you even then it gets a little murky as you try to apply IBNR factors and really understand how this will all play out, but I think the story will stand up. So I would say we have decent visibility into the first quarter.
Shawn M. Guertin
But really little beyond.
Dale B. Wolf
But little beyond that. I don’t think the macro story, obviously, will change. Now could we see some componentry potentially moving around when we get down into the subclass of outpatient? That’s a possibility when all is said and done.
Justin Lake - UBS
Were you able to trend how March looked versus February versus January?
Dale B. Wolf
That’s very hard because it’s very workday driven and in fact, for example, this quarter, January has the most weekdays so the costs tend to follow that. Plus you had the ups and downs of flu going on in there. But let me be clear on that.
I don’t really have any evidence today that this is accelerating. And so that’s the basis for carrying this forward. I don’t have any evidence it is decelerating either, but when we look at the data as best we can when you’re dealing with a few months and you’re trying to pick up a trend, I don’t see any evidence it’s accelerating beyond the level that it’s at today. That could happen, but it could also decelerate. We don’t have any evidence either way right now.
Justin Lake - UBS
And just a quick question on private fee for service and the claims recognition. I think you did mention that some of your processes need to be improved there as far as bringing those claims and getting them processed. But you talked a little bit about the provider recognition and the processing being 30 to 60 days behind as they find out where these people are actually short.
Why would that, given that you were in private fee for service for the full 12 months in 2007 why would that be a late year event? Wouldn’t your completion factors have seen that type of issue before the end of the year? And just maybe in addition to that, can you just spike out, was there any thing in group that was different as far as these completion factors versus the individual?
Shawn M. Guertin
The problem is, is that in the first year of a product, especially when you’re rapidly adding membership, and as you remember, we had some ups and downs in inventory. The claim lag factors are very difficult to use and, frankly, don’t have a lot of credibility. Your point is valid, though.
I share the example with you not to per se explain the problem as much as to explain some of the factors behind the length of the lag. At the end of the day this comes down to the fact that the lag was longer than we were estimating it by both looking at the factors and looking at some other metrics.
And I mentioned, there are some internal things that not only have to do with claim processing speed, but have to do with our insight into the claim processing of this and the analytics around that that we’ve discovered needed to be improved. And in many ways that is equally as important an issue here in terms of how we found ourselves in the position that we were in.
The group products actually, to no surprise, especially because they’re jumbo accounts, are experiencing a shorter lag than the individual, and I think that it’s because there’s much more provider awareness of who the provider is that’s covering the plan. A lot of these things have been splashed in the paper. So there is a noticeable difference, for example, on the West Virginia account in terms of the time to receive and pay claims than there is on our broader based individual book of business.
Operator
Your next question comes from Scott Fidel - Deutsche Bank.
Scott Fidel - Deutsche Bank
Can you give us just an update on what you view now as your underlying cost trend? I think you had previously been at 7.5%. And then maybe if your updated view on where your price to cost spread will be for 2008?
Shawn M. Guertin
Well the price to cost spread will be about 150 basis points the wrong way, i.e., the MLR will be up 150 bps and to that end we’ve taken our trend up by about that amount. So if you want, I can give you the new factor. So you think about it as 7.5% is going to approximately 9% and we’d be looking at inpatient 10% to 11%, which would be up 200 basis points. Outpatient would be 11% to 14%, which is up 400 basis points. And then physician and pharmacy are unchanged at 6% to 7% and 6% to 8% respectively.
Scott Fidel - Deutsche Bank
The trajectory of your costs from 1Q to 2Q, is your analysis just that costs have accelerated in 2Q over 1Q or is it more that you think you had initially underestimated the baseline of the 1Q costs, maybe they’re relatively stable from 2Q to 1Q, but you had a lower view or a higher view now of the 1Q costs?
Shawn M. Guertin
Yes, it’s more you’re latter. Simplistically, if we think the year will come around 80.3, we reported 78.8 in the first quarter. And so what’s going on in the second quarter is obviously catching up on that, plus the reset to the higher level in the second quarter.
As I mentioned before, we don’t have any evidence that the trend is accelerating and so I don’t expect that there is any at this point, I don’t have any evidence of further acceleration into the second quarter. Let me be very clear, we have very limited visibility on two months, with just two months of pay. But I don’t have any evidence that that’s accelerating.
Scott Fidel - Deutsche Bank
And then just relative to your forward pricing view at this point. Is it comfortable now to assume that you’re going be looking to comfortably clear that hurdle of 9% on the forward pricing?
Shawn M. Guertin
That remains to be determined on our second wave. We will at least get the 150 basis points of trend outlook into our forward pricing. As I mentioned, we’re actually looking at that right now and thinking about how much we can and should push in a second wave. But what I would tell you today is that we will at least get the trend up to that 9% level.
And again, I want to point out that, again maybe for the wrong reason but the right result, we had started this going all the way back to March in a more opportunistic fashion increasing our trend factors back then by 100 basis points. So the good part of that is we have caught a significant amount of our ‘09 business with that change.
Scott Fidel - Deutsche Bank
The lower commercial risk guidance, how much of this would be building in an assumption in terms of the impact from the forward pricing actions that you’re planning, as compared to maybe reductions in enrollment that you’ve already seen in the second quarter?
Dale B. Wolf
It’s much more of about the strength of sales and reductions that we’ve already seen. In fact, the pricing change will have a much smaller impact, if you will, on 2008. So for example, we’re not hitting much on the large group front in 2008 and we’ll probably be catching the back half of the year on small group. But that outlook has much more to do with where we see our membership forecast going now then it does with the price increase.
Operator
Your next question comes from Matthew Borsch - Goldman Sachs.
Matthew Borsch - Goldman Sachs
Could you remind us how much of your commercial group book is large group versus small group as you divvy it up?
Shawn M. Guertin
It is roughly a third small group and we define that as under $50. I always forget the numbers, Drew, so correct me. I think 500 and up is another third and then the other third is in between the two.
Matthew Borsch - Goldman Sachs
How much of your commercial business for 2009 have you already repriced or have you set in place with rates?
Dale B. Wolf
Well, I would say I think conservatively that for example when we put the 100 basis points of trend in, we will probably catch something like 80% of all of the business that will impact ‘09. For example, we would miss a 07/01 large group but we caught most of the 01/01/09s.
So and maybe a different vantage point on that is a lot of the very large January accounts have already gone into the process and the renewal process and are working. But we’re really still working on a lot of the mid size and the small accounts for ‘08 effective date renewal. So we capture most of that.
Matthew Borsch - Goldman Sachs
Your outlook on turning to the private fee for service product with the outlook for high 80s MCR, my understanding is that’s where a few of your competitors have been for a while., In retrospect, is that now the right run ratio to be for this product rather than the numbers that you had assumed earlier?
Shawn M. Guertin
I think that’s right. As Dale mentioned even with the $50 million of restatement with this product probably performed in the mid 80s. In ‘08, to your point, we are now forecasting it up in the high 80s and that is very consistent with our pricing target. So I think that is a fair way to think about where this product will be going forward.
Matthew Borsch - Goldman Sachs
Can you talk to the, aside from the claims lag, when you’re looking at the higher trend on the inpatient side, the higher trend on the outpatient side, understanding the first one is unit price based and the second one is utilization, did you fundamentally know what the driver is for the problem or the spike in the first place?
Dale B. Wolf
No, I would say that’s the stage we’re in Matt, is to try to figure that out and we’ve been able to rule some things out, like we haven’t written a bunch of bad new business, if you will. So this is happening sort as to our in force block, obviously that we’ve had. But to be honest with you, we don’t know all the answers, but I want to amplify that that we haven’t waited for the answers to take the corrective action.
We’re going to keep digging at that and hopefully we will find things that are either temporary, as the severity spike may prove to be, or we’ll find things that we can do, benefit design, contracting, medical management, as we always do. But I would not tell you right now that I have a full understanding of every driver as to what’s happening there.
Operator
Your next question comes from Carl McDonald - Oppenheimer.
Carl McDonald - Oppenheimer
The 100 basis point increase that you talked about in planning starting in March. Have you seen any evidence that any of the competitors have done the same thing? Whether it’s because of some of the issues described by other publicly traded companies or maybe from the blue perspective of the interest rate environment?
Shawn M. Guertin
Well, certainly, that might have been your stuff, Carl, but there has been stuff about Highmark pushing price in Western Pennsylvania. I think that’s fairly well-known. I don’t think that I can think of a real concrete example where I seen evidence of renewals or rate increases that might be tied some of the more near-term stuff, so I don’t know the answer to that question 100%.
Carl McDonald - Oppenheimer
In terms of the private fee for service loss ratio in the high 80s, is there any differentiation now between the assumed loss ratio in the group accounts versus the retail accounts or is that pretty consistent now?
Shawn M. Guertin
The group account would be slightly high. The group accounts can be depending on the size of the group anywhere from the very high 80s into the low 90s. Still a bit higher, but a lot closer obviously than it was.
Operator
Your next question comes from Charles Boorady - Citi.
Charles Boorady - Citi
I just wanted to be clear on the delayed cycle time. Is that something you were already aware of, but it took you longer to identify the higher cost trend because of it or did you just discover recently that the difference between the incur date and the pay date was a lot longer on private fee for service than you previously thought.
Dale B. Wolf
Yes. I want to be clear. There is not a cost trend problem in the private fee book. I would think of it more as a recognition of where we really were performing last year. We had certainly always been building in longer cycle times on the product. It has just proven to be even longer than I think we even imagined that it could be.
And again, I don’t want to blame everything on the cycle time because to some extent to your point of your question, we were aware of that. There are some things internally that we discovered over the last few weeks that we’re an analytic gap that we had in terms of understanding the cycle time better.
Charles Boorady - Citi
Can you be more specific about that and was it related to the change in your technology? Or was it just somebody not looking at a report that was already being produced?
Dale B. Wolf
Yes, it actually, it had to do, Charles, with claims. In the product we are required to pay just as Medicare does. And what we had discovered is that a sizeable number in dollar amount of claims had been denied because certain Medicare required elements were missing from the claim. But they weren’t denied because we weren’t going to ultimately be liable for them. They were just denied because they had come in without that.
Well, the simplest way to think about it is they went in and out of our system and looked like a denied claim, and we never saw them as inventory. And so when we kept accessing the reserve, we didn’t know that this liability was out there is the best way to think about it. And we torn this apart, needless to say, and have discovered and now been able to quantify what that potential liability is and have built that into our estimate. So, again, that’s an interesting problem because, per se, nobody was doing anything wrong in operations. They were doing what they were supposed to do. But where it broke down was making sure that we had an understanding of that potential liability in the reserve-setting process.
Charles Boorady - Citi
I see. And the fix to this?
Dale B. Wolf
The fix is that as you can be assured that we know more about the private fee for service claim processing than we ever wanted to know, but we now have very detailed analytics about all of the claims that are denied for this reason.
I want to point out too that this is not something new on private fee for service. We have administrative denials all the time on commercial, on Medicaid, on Medicare Advantage HMO. It was really the level of administrative denials here was much higher than we had on our other products, and then to some extent we developed a blind spot in assessing the potential liability on this until we tore this apart.
Shawn M. Guertin
Because your lag factors, Charles, they anticipate, if you will, the same level or proposition of administrative denials as you have had on your other products and processes over time. And so if you get a new product, which for whatever reason has a higher level of denials, unless you make a specific adjustment for that, your lag factors will understate it.
Charles Boorady - Citi
I understand there was other changes to coding that could result in higher than normal administrative denials as well. Is that something you’re seeing from hospitals?
Dale B. Wolf
I wouldn’t have said that around the administrative denial issue. The other issue that we’re spending some time on, actually, is the implementation of MS-DRGs at the end of the year. By no means do I want you to misinterpret this and think this is the whole problem. But that was another part of the cost issue here that we were trying to teethe out as well is that those MS-DRGs were implemented 10/1.
And it does appear that the effect of those is a bit higher at this point than we had originally modeled. So, again, to get it out there, it’s not really “as much the reserving problem”. But I would tell you the most recent development issue is trying to understand what’s going on with hospital coding related to the MS-DRG change at 10/1.
Charles Boorady - Citi
And based on the longer cycle time, are you changing any assumptions on reserving such as booking a higher contingency for adverse developments?
Dale B. Wolf
We’re certainly considering that and did consider it, in what we will do in the second quarter.
Charles Boorady - Citi
So in your 2Q, you will begin to include a higher estimate for adverse developments.
Dale B. Wolf
I would actually say that the best estimate we have right now is that we will be higher than our typical product is at the end of the second quarter.
Charles Boorady - Citi
What was the prior period development? Can you tell us roughly what we’re going to see on your roll forward tables, and how it would breakout between Medicare and commercial?
Dale B. Wolf
Yes, our guess, and again I have not seen June yet. So this is a little bit of a guess, but it would look like aggregate $40 million of favorable development versus last year. Put $50 on top of that, that’s private fee, and think about that, that’s $90 without the bad guy.
Charles Boorady - Citi
So $90 is the delta or the total amount.
Shawn M. Guertin
No, no, I’m saying, what do you want me to take the delta from?
Charles Boorady - Citi
Well, the difference from last year’s development or are you telling us the absolute dollar amount of this year?
Shawn M. Guertin
Last year the development was around $112 million that we reported. It will be $40. So the explicit difference as estimate it today is the difference, but obviously $50 million of that is tied up in private fee.
Charles Boorady - Citi
How are your assumptions on private fee for service for ‘08 changing now as a result of what you learned about ‘07? Are you just bumping up the baseline trend assumptions based on how much higher ‘07 was than you thought? Or is there, is it prudent to throw in some additional contingency considering the change in lives this year from last year?
Shawn M. Guertin
We pushed up the base and we added some contingency for deterioration and obviously there was multiple factors that went into our thinking on that. And that was what we observed on the MS-DRG’s for example.
Charles Boorady - Citi
How far back did the $50 million go into ‘07? Was that all third and fourth quarter?
Shawn M. Guertin
It’s all, it’s more weighted there, but we are still paying and receiving claims back in the first quarter of ‘07. So there is movement all the way back through the quarters.
Operator
Your next question comes from Matt Perry - Wachovia.
Matthew Perry - Wachovia
If I’m thinking about it correctly, on the Medicare Advantage a negative prior period development of $50 million would subtract $0.20 or $0.21 from guidance and then the change in the ‘08 assumption would subtract another $0.21, if my math is right. But, the book of business has grown in ‘08 so, just thinking that way, it seems like you haven’t made any contingency in that. Or am I thinking about that wrong?
Shawn M. Guertin
Well, remember that we had always built in some provisions that the MA loss ratios were going to go up in our guidance. That’s always been baked into our additional guidance.
Matthew Perry - Wachovia
And maybe I’m getting ahead of myself, but you’ve talked about in the past an earnings growth rate, EPS growth rate of low double-digits. Can you talk to us about how we should think about ‘09 given maybe some of the non-recurring factors here in ‘08?
Shawn M. Guertin
I think I can answer that question more from a long-term vantage point. I don’t want to find myself in the position of giving ‘09 guidance here. But I think we have largely put these problems behind us now. And when I think about this business long-term, it certainly seems like EPS growth rates that might range from the high single-digits into the low double-digits would be appropriate and candidly, I think it’s what we would expect our people to deliver internally as well as a bogie. So that’s the way we think about it. It requires good execution, but I don’t see it requiring unbelievable execution to pull that off.
Matthew Perry - Wachovia
You’ve talked about a few issues here that seen mostly company specific and given the backdrop of all the other things that have been going on in the sector with other companies lowering guidance, is this more coincidental or do you think there is a broader theme that’s going on here?
Shawn M. Guertin
Well, that’s probably ultimately better easier for you to determine then me. But I agree, I don’t I think the privacy for service issue is largely a recognition and timing issue for us. And so I don’t really perceive that anybody per se would have that problem. I think, again, it’s probably you need to be the judge of if we have experienced the cost push in Q1, how that ripples through others in the system.
Operator
Your next question comes from Doug Simpson - Merrill Lynch.
Doug Simpson - Merrill Lynch
Dale, if you could flush out a little bit more of your earlier comments about expense reductions in light of what’s been going on, and maybe just talk to us about how you balance some of the initiatives you need to pursue to get your arms around the challenges you have this quarter with potential expense reductions?
Dale B. Wolf
No matter how tight the ship is, there is always opportunity to tighten it a little more. Don’t forget the G&A of this company in the last four years has tripled and its employee population has tripled. So to suggest, in a period of material growth that we have experienced, that we have done everything perfectly and that there’s no more room to be better, is crazy.
So that’s the impression we went in to this with, this isn’t about saving your way to prosperity, it’s one of the levers we have to push. So we tightened our belt effective today on some staffing levels. And just to give you a sense of that, we’re a little over 15,000 employees in this company and more or less what we were asking people to do is not let that number grow throughout the year as opposed to ripping the guts out of it.
On some of the non-salary items, frankly, there’s too many express mails showing up on my desk that I don’t even need, let alone expressed. And so it’s express mail, its travel, it’s just some of the typical non-salary items that we could just tighten up a little. We were trying to reach the right balance. Do I believe that important significant efforts for growing this company in the future will be affected? No, I do not.
Doug Simpson - Merrill Lynch
You have historically I think had pretty tight reins on the execution side of things. This quarter we come in, we’ve the private fee for service discovery or issue. You’ve got the commercial cost issue, the commercial membership issue, the workers’ comp billing issue. That’s a lot of stuff to throw out here in one quarter and I’m just wondering as you step back and think, do you think is that pointing to anything organizationally or is there just coincidence that it all popped up in one quarter?
Dale B. Wolf
Doug, I think you’ve got to take those one at a time. The workers’ comp, I’ll overreach this to say there’s always stuff you can do better in every business, but the workers’ comp volume issue is more related to industry volume issues reflected in the current economic environment. I think you’ll find it across most comp-related businesses.
We can do stuff better, but I think that’s the primary one there. In the commercial business, frankly I am not sure we feel like there is much execution fall down there. It’s mostly related to how soon do you find out about a cost trend and a spike in cost trend. So I am not naive about this stuff, but the only real execution issue we find here is in private fee. And by the way, it had nothing to do with the final result, only the timing of recognition. So it’s a good question, but doesn’t feel that way.
Operator
Your next question comes from John Rex - JP Morgan.
John Rex - JP Morgan
On one of the line items that you spiked out here, the other operating modifications. Can you just tell us, get little more breakdown on the composition of that line? It looks like there is a pretty reasonable reduction in the SG&A spend. And I just wanted to see what else might be going on in that line item?
Shawn M. Guertin
The biggest drivers on the top line really are taking the commercial risk membership growth assumption from flat to minus 4%.We backed the Medicare membership assumption down from 100,000 member growth to 90. And there is lot of other things that we’ve tweaked as we’ve gone through the full reforecast. But those are the top line drivers.
We mentioned the workers’ comp which is the other fee based top line driver. The biggest other item there is SG&A, and that is a combination of lower expenses that naturally flow with volume like commissions and premium tax. To some extent, the expense actions that we’ve been taking and we’ll continue to take that Dale mentioned.
And frankly, there’s things like performance based comp that obviously will also come out of the SG&A as well. So we’ve generally gone through a full reforecast and reassess the whole SG&A line. Those are the biggest moving pieces that contributed to the minus nine.
John Rex - JP Morgan
And just kind of roughly on G&A is about coming down like roughly a little under $100 million, I think. How much of that is the performance comp number?
Shawn M. Guertin
It’s in the neighborhood of $40 to $50 million.
John Rex - JP Morgan
Overall the G&A reduction is providing a $0.30 to $0.40 on what you’re doing today. Is that right?
Shawn M. Guertin
Yes, I think midpoint to midpoint, the SG&A is down 75.
John Rex - JP Morgan
And then just on the outpatient costs, I think your perspective has generally been that medical cost trends don’t change quickly. And 400 basis point swing factor seemingly gets into that category of meriting a quickly definition. What I haven’t heard is what some of the initiatives are. Do you think the trend is just to reset here? What would be the action plan to get at some of these components that are driving the higher utilization on this side?
Dale B. Wolf
Yes, it’s, it’s something, John, that as I mentioned, we’re still working on. But if you went component by component on things like ER, we’ve been through our benefit plans in the past to make sure co-pays are higher enough, but that sort of where you hit that one first and foremost.
You’d certainly look at all of your preauth procedures around radiology and hi-tech imaging and you’d go back through that again. Again, it’s benefit design, it’s medical management, and it’s potentially contracting and education to a lesser extent with the members. So I don’t know that I have the full action plan on everything yet, because I don’t know that we understand fully exactly what’s driving all of it, but obviously that’s the things we will be working on.
John Rex - JP Morgan
But it doesn’t really sound like the member mix hasn’t changed all that much and the benefit design probably hasn’t been that dramatically different. Some of the things you were commenting on, your new plans are running as expected. It’s the legacy plans where this occurred, isn’t that correct?
Shawn M. Guertin
That is correct. That’s the way it appears today.
John Rex - JP Morgan
When have you seen a 400 basis point swing factor in a category like that? Because I’m trying to remember back in history, for Coventry at least, have you ever seen anything of this magnitude in the last four years?
Shawn M. Guertin
I would say it’s certainly at the high end of a swing that we’ve seen. I can’t see definitively we’ve never experienced this. Again, we’re inside one category in one quarter and that can be bouncy and we’re now making a call off of that one quarter for the year. So my guess is I could go find a quarter where things inside one of the subcategories move 300 or 400 basis points.
John Rex - JP Morgan
And there is nothing in completion factors that could have changed in this quarter also?
Shawn M. Guertin
Not really. Not meaningfully enough to change the answer here.
John Rex - JP Morgan
And then just I wanted to be clear on your view on commercial MCR and your pricing actions for ‘09? So is your view, you can recapture the lost margin this year in ‘09 that you can fully recapture or was that, I wasn’t clear on your answer.
Shawn M. Guertin
Yes, I don’t want you to go there. At this point, I would only tell you that we are going to catch the trend factors up to this higher level of trend, which in, to the point of your question, the end result of that should be to keep the loss ratio steady in ‘09 versus ‘08.
John Rex - JP Morgan
So keep it steady at this new higher level?
Shawn M. Guertin
Correct.
John Rex - JP Morgan
I know you’re not forecasting ‘09, but that’s how you would think about? Once you do start developing in ‘09, you are going to be thinking about those as jumping off points?
Shawn Guertin
Yes, there will be two things that we will do in addition to that. As I mentioned, we are going through a second wave of price increases. The magnitude of that second wave will be at least enough to keep us even, but we will make decisions about whether we push harder than that or not. And obviously we’ll continue to study trends. But I would say today the baseline would be that it should, we would have every intention of trying to hold this new higher loss ratio at least flat.
John Rex - JP Morgan
So, and so implicit in that for now you are saying, for what you know now, your go for assumption is that this new 9% trend factor is the new trend factor.
Shawn Guertin
Correct.
Operator
Your last question comes from Michael Baker - Raymond James.
Michael Baker - Raymond James
My question relates to the comment that you made in terms of DRG changes last October. I was wondering if that had any flow through or contributory effect on inpatient on the commercial side in terms of unit cost dynamics.
Shawn M. Guertin
Yes. But it’s to a much lesser extent, only about 15% or so of our commercial inpatient spend is tied to a Medicare-based contract.
Operator
We are out of time for questions.
Dale B. Wolf
There are none. Thank you for your attention this afternoon.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!