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Executives

Michael Kleinman – VP IR

Angela Braly – President & CEO

Wayne DeVeydt – Executive VP & CFO

Ken Goulet – Executive VP

Brian Sassi – Executive VP

Analysts

Doug Simpson - Merrill Lynch

John Rex – JP Morgan

Matthew Borsch - Goldman Sachs

Justin Lake – UBS

Charles Boorady - Citi

Joshua Raskin - Lehman Brothers

Scott Fidel - Deutsche Bank

Peter Costa - FTN Midwest Securities

Carl McDonald - Oppenheimer

Mike Baker – Raymond James

WellPoint, Inc. (WLP) Q2 2008 Earnings Call July 23, 2008 8:30 AM ET

Operator

Welcome to the WellPoint Inc. quarterly results conference call. (Operator Instructions) I would now like to turn the conference over to the company's management; please go ahead.

Michael Kleinman

Good morning and welcome to WellPoint's second quarter earnings call. I’m Michael Kleinman, Vice President of Investor Relations. With me this morning are Angela Braly, our President and Chief Executive Officer; Wayne DeVeydt, Executive Vice President and Chief Financial Officer; Ken Goulet, Executive Vice President and President of our Commercial Business and Brian Sassi, Executive Vice President and President of our Consumer Business.

Angela will begin this morning's call with an overview of our second quarter challenges, actions and accomplishments. Wayne will then offer a detailed review of our second quarter financial performance and current guidance, which will be followed by a question-and-answer session in which Ken and Brian will also participate.

We will be making some forward-looking statements on this call. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of WellPoint. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to review the risk factors discussed in our press release this morning and other periodic filings we make with the SEC.

I will now turn the call over to Angela.

Angela Braly

Good morning and thank you Michael. In the second quarter of 2008 we began to see a number of improvements as compared to the first quarter. Our GAAP net income was $1.44 per diluted share and included $0.03 per share in net realized investment losses. We had another quarter of record premiums and revenues. Both are benefit expense ratio and selling, general and administrative expense ratio declined sequentially contributing to a 35% sequential increase in pre-tax income.

We now expect full year 2008 earnings per share to be in the range of $5.42 to $5.57 which includes $0.06 per share in net realized investment losses. Based upon results through the first six months of the year, including membership mix changes, lower expected fully insured membership and our settlement of certain California rescission issues; we have narrowed the EPS guidance range we provided last quarter.

Wayne will update our second quarter financial results in detail later on this call but first I’d like to take a few minutes to discuss membership, competition and the actions we have taken and steps we’re continuing to implement in order to improve our performance for the rest of 2008 and beyond.

At June 30, 2008 our medical enrollment totaled approximately 35.3 million members, an increase of more then 500,000 members or 1.5% from 34.8 million at June 30, 2007. Enrollment in our national business increased by 626,000 including 319,000 new national account members and 307,000 Blue Card members. National accounts are among the most sophisticated groups in evaluating buying decisions and these results show that they continue to appreciate the value proposition, the product and the services we provide.

Local group membership in our Blue states increased by 222,000 members over the past 12 months while our non-Blue, UniCare and Health Link business declined by 261,000. As of June 30, 2008 52% of our medical enrollment was self-funded and 48% was fully-insured. At June 30, 2007 our membership was almost equally split with self-funded and fully-insured each comprising 50%. Our membership base is evolving as we continue to gain share in the self-funded marketplace while fully-insured enrollment is being impacted by economic conditions and competitive dynamics in certain geographies.

Membership declined sequentially by 99,000 members in the second quarter of 2008 which included our withdrawal from the Ohio Covered Families and Children Medicaid Program or Ohio CFC that covered 142,000 members. In order to participate in state sponsored business we need to receive actuarially sound rates and unfortunately in Ohio we weren’t able to do so.

Other states are also experiencing financial difficulties due to the current economic conditions that do affect state funding. We recently announced that we intend to exit Nevada state sponsored business at year end. This will impact approximately 50,000 members. It is disappointing that we were unable to continue to participate in the Ohio and Nevada programs. Managed care can provide valuable benefits to state governments and the Medicaid and S Chip beneficiaries. We will continue to work with our state partners to create environments in which we can provide these benefits in an actuarially sound manner.

We also saw a sequential membership decline in our individual and local group businesses. This follows rating actions in certain markets and we believe also reflects the general economic conditions of the country. Overall we achieved our targeted price increases in the second quarter and gross margin on a per-member per month basis expanded for the 12 months ended June 30, 2008. However our membership declined a little more then we had anticipated. To stimulate our sales we are introducing new products in a number of states with varying price points and alternative benefit designs.

As an example in Georgia, our new product portfolio implementation for the SmartSense and Premier plans is nearing completion. Marketing and communication plans are underway and broker registrations to learn about these new products have exceeded projections by 25%. In the innovative Healthy Indiana plan, that help individuals who earn too much to qualify for Medicaid but not enough to afford coverage in the commercial market the state has received more than 50,000 applications year-to-date and 19,000 have been approved so far. More than 70% of the members selected [inaudible]. We expect continued growth in this innovative program that if it’s successful could serve as a model for the rest of the country.

In addition to rolling out new medical plans we expect continued enhancement to our specialty product portfolio. During the second quarter we announced the acquisition of DeCare Dental one of the country’s largest administrators of dental benefit plans. DeCare is a leader in administering dental benefits and DeCare’s unique tools and services can improve our future revenue growth and create more opportunities to improve the health of our members as there is a linkage between oral health and medical conditions.

Upon completion of the acquisition WellPoint will provide and administer dental benefits to approximately nine million members and have one of the nation’s largest dental PPO network. We expect this transaction to close during the third quarter. We are currently developing our business plans for 2009 and have an early look at the 2009 national accounts membership forecast. The selling season is in full swing and our service delivery, clinical integration, and network discounts are keys to our continued success in this market.

We have a number of new sales and in-group growth already booked for January 1, 2009 and there are additional notable prospects being actively worked. We are excited about our outlook for national accounts and expect good net membership growth in this segment next year. In the senior market as we noted earlier this year we have experienced higher claims trend in our Medicare Advantage private fee per service program due to certain benefit designs that resulted in adverse selections.

Last month we filed new pricing and adjusted benefit designs to help ensure that our 2009 Medicare Advantage plan are competitive and appropriate and we expect funds better underwriting performance in this business next year. We are also working to optimize the cost of care and implementing additional medical management initiatives for our seniors. To attract new senior members we have completed detailed competitive assessments and are piloting an [aging] program for individual members approaching their 65th birthday.

The senior segment is an important part of our growth strategy. With the baby boomer generation aging seniors are a growing part of the population. We’re in this business for the long-term and we will make the necessary corrections to return this product segment to successful performance. Overall we see competitive but generally rational pricing across our customer segments. We are seeing competitors offering rate caps, reducing or forgiving the first month’s premiums and guaranteeing medical savings to compete against our value proposition.

We are the market leader in almost all of our Blue states with the most recognizable brand names, the largest medical membership base nationwide and unit cost advantages in most of our service areas. As the leader we price our products in a disciplined and actuarially sound manner. We also offer access to the broadest and most cost effective provider network in the country. These advantages continue to win in the marketplace because they place us in a truly unique market position from which we can positively impact the cost and quality of healthcare in this country.

Medical cost trends drive premium increases. Through our contracting efforts, pay for performance initiatives, medical management, advanced care management, health improvement, wellness programs, and data analytics we have numerous tools that help constrain the rising cost of healthcare while improving healthcare quality. These programs require significant investments, many of which are reported as administrative expense in our financial statement. This is one reason why regulatory efforts to limit heath plan benefit expense ratios can actually have an unintended consequence of driving up healthcare costs.

If minimum benefit expense ratios are imposed without an appropriate definition valuable investments such as those I’ve just described that have been proven to lower costs and improve the care of people with chronic illness unfortunately may be forced to be curtailed.

We continue to do a good job of holding down our own administrative costs. In the second quarter of 2008 our general and administrative expenses are less in actual dollars then in the second quarter of 2007 while we served over 500,000 more medical members in the current year quarter. Over the past seven years we have reduced our selling, general and administrative expenses as a percentage of operating revenue by 690 basis points.

Now I’d like to provide a brief update on other aspect of the performance improvement plan we’ve put in place this year in response to our challenges. We continued to execute on our performance improvement plans during the quarter. It is designed to improve our ability to manage our business and compete affectively over the long-term and we are already seeing positive results from these efforts.

Claim inventories for fully-insured business are down 23% from December 31, 2007 and have returned to normal levels. Both the level and aging of our claims inventory continues to improve. Our claims processing speeds have increased as evidenced by the increased percentage of claims being paid for recent incurred months. Increasing processing speed improves our customer service, provides greater visibility for actuarial reserving estimates and enables us to price more accurately.

We’re making significant strides in resolving issues impacting primarily self-funded claims in limited geographies that were caused by one of our system migrations. We reduced inventories on that system by more then 33% since February, know what the issues are and have taken steps to minimize provider impact relating to this issue. We expect to have these issues resolved by the end of the year.

We experienced both favorable prior year and favorable intra year reserve development during the second quarter. On a year-to-date basis prior year reserve development was favorable in the amount of $270 million which was less then in 2007 but in line with the expectation we had as of last quarter’s earnings call.

Our benefit expense ratio declined by 180 basis points sequentially to 83.3% in the second quarter of 2008. The decline reflected positive impacts from our medical management initiatives, favorable reserve developments we experienced in the second quarter and improvement in our senior benefit expense ratio. The Medicare Part D benefit expense ratio improved due to seasonality and while our Medicare Advantage benefit expense ratio also improved from the first quarter of 2008, it remains above our targeted range.

We continue to expect our benefit expense ratio to be in the range of 83.3% to 83.6% for the full year of 2008. One of our internal enhancements was the creation of the WellPoint Operations Counsel chaired by Ken Goulet who leads our Commercial Business unit. The Counsel is comprised of six executives who manage the areas that most directly drive our operating revenue and profits. The members include Brian Sassi, who leads our Consumer Business unit; Dijuana Lewis, President of Comprehensive Health Solutions; Cyndi Miller, Executive Vice President and Chief Actuary; Lori Beer, Senior Vice President and Acting Chief Information Officer; and Gloria McCarthy, Senior Vice President of Operational Excellence.

This team has been charged with ensuring that our performance improvement plan is well executed and this team is accountable for attaining our operating targets and maximizing profitable growth. The counsel will work closely with Wayne DeVeydt and Brad Fluegel, Executive Vice President of Strategy and Public Affairs, to ensure that it’s operational planning is properly aligned with our short-term and long-term financial and strategic goals.

With the focus and leadership of this operations counsel and the support of the rest of my executive leadership team I believe that we will continue to execute on our plans to improve performance and enhance customer and shareholder value. Our vision is to transform healthcare and become the most valued company in our industry.

I’d like to also acknowledge a couple of key leaders who have recently joined Brian Sassi’s Consumer Business unit. Considerable progress has been made assessing, changing and upgrading the Consumer Business management team to position us for profitable growth. This month Raj Bal joined WellPoint as Senior Vice President and President of our Individual Business. Raj comes to us from Assurant Health, where he was Executive Vice President and Chief Operating Officer overseeing individual medical, small group, specialty and worksite businesses as well as sales, marketing, actuarial, operations and network management.

And as announced last quarter Kevin Hayden is now leading our State Sponsored Operations. Brian and his team have made significant progress in identifying the issues facing our individual, senior and state sponsored businesses and are initiating actions to improve performance. So as we begin the second half of 2008 we have a plan to improve performance, a structure to ensure that we do so effectively, and we have already begun executing on this plan.

While we continue to face business challenges including weak economic conditions and a competitive marketplace we believe we have the right team and structure in place to provide even better service to our customers and enhance shareholder value.

Wayne will now discuss our second quarter financial statements, medical cost trends and provide additional guidance details.

Wayne DeVeydt

Thank you Angela and good morning. I also believe that we are making good progress on our performance improvement plans and I think this is reflected in our 2Q 08 results. In the second quarter of 2008 premium revenue reached $14.3 billion, an increase of $409 million or 3% from the prior year. This increase was driven by rate increases across all medical lines of business and growth in our Medicare Advantage products partially offset by the loss of the New York State prescription drug contract and lower fully-insured commercial and state sponsored membership.

As Angela noted, we achieved our targeted commercial price increases in the second quarter although this contributed to a slightly higher level of membership attrition then we anticipated. We also continue to see benefit buy-downs this year including continued migration into higher deductible and consumer driven health plan offerings. In fact our CDHP membership has grown to 1.7 million as of June 30, 2008 an increase of 466,000 or 38%. Compare this with this time last year. Our fully-insured CDHP membership has grown by 340,000 or 54% over this period.

Offering CDHP and other high deductible product as compliments to our more traditional product designs allows us to target a variety of audiences in our efforts to grow and retain profitable fully-insured membership. Administrative fees totaled $966 million in 2Q of 2008 an increase of $43 million or 5% from 2Q of 2007. This was driven primarily by revenue for medical management programs offered by our comprehensive health solutions business and strong self-funded membership growth.

We continue to be a market share taker in the ASO business due to our superior value proposition. In total our self-funded enrollment increased by 1.1 million or 6% from June 30, 2007. The benefit expense ratio was 83.3% in the second quarter of 2008 an increase of 150 basis points from the same quarter of last year, approximately 90 basis points related to higher cost and membership mix changes in our local group business.

As we have previously discussed we believe our initial pricing for 2008 was approximately 90 basis points below medical cost trend and we also experienced a lower level of favorable reserve development this year. We took actions to address these issues and now have a slightly more favorable outlook for our local group benefit expense ratio over the second half of this year then we had on our last earnings call. Approximately 45 basis points of the quarter-over-quarter increase in our benefit expense ratio results from higher medical costs in our Medicare Advantage products.

We are deploying new medical management initiatives to address this high claims experience and have adjusted our planned designs and pricing for 2009. However we now expect our Medicare Advantage business to deteriorate more during the second half of this year then we had previously expected. This essentially offsets the expected improvement in local group leaving our full year 2008 guidance for the consolidated benefit expense ratio unchanged at 83.3% to 83.6%.

We are pricing our business so that our expected premium yield exceeds total cost trend. Total cost trend includes medical cost and selling, general and administrative expenses. Based on results to the first six months we continue to expect that full year 2008 medical cost trends will be in the range of 8% plus or minus 50 basis points. For the 12 month period ended June 30, 2008 unit cost increases continue to be the primary drivers of medical cost trends.

Inpatient hospital trend is in the low double-digit range and is almost all related to unit cost increases. Inpatient utilization measures such as admissions per thousand days of care, one thousand and average length of hospital stays, have been increasing slightly. We are addressing in-patient unit costs trends through contracting initiatives and reducing hospital stays through our clinical management efforts such as neonatal intensive care programs and oncology care programs.

Outpatient trend is in the mid to upper single-digit range and is about 85% related to unit cost increases and approximately 15% utilization related. The primary drivers of outpatient trend continue to be out patient surgery and emergency room cost. We have a number of initiatives underway to address outpatient costs including contracting initiatives with labs, [durable] medical equipment, physical therapy, and occupational therapy.

We are also seeing a positive impact from expanding AIM’s radiology management programs across the country following our acquisition last year. We will have AIMs radiology clinical management programs in 12 of our 14 Blue states by year end. Physician service trend is in the mid single-digit range and is approximately 55% unit cost driven and 455 utilization. Fee schedule changes are one of the drivers of these trends. We are collaborating with physicians to improve the quality of care through pay for performance programs.

Pharmacy trend is in the mid single-digit range and is approximately 60% unit cost and 40% utilization driven. The increased use of specialty drugs is a primary driver of the higher cost trend and we manage the distribution of these drugs through our Precision Rx Specialty Solutions mail order facility. We have also initiatives in place in our PBM to increase generic drug usage.

Our selling, general and administrative expense ratio was 14.3% in the quarter a decline of 80 basis points from the second quarter of last year primarily due to low incentive based compensation in 2008. We continue to have effective expense control across the company. Net investment income in 2Q 2008 decreased by $36 million or 14% from 2Q 2007 to $218 million primarily due to reduced investments resulting from the use of cash for repurchase of our common stock.

Interest expense increased $16 million or 16% to $117 million in the second quarter of 2008 primarily due to the issuance of $2 billion of long-term debt during 2007 and in increased use of commercial paper this year. Both investment income and interest expense are in line with our expectations. While both of these are subject to interest rate fluctuations we have implemented investment strategies across our diverse portfolio to minimize the impact of short-term interest rate swings.

Net realized losses were $28 million in 2Q 2008 and were driven by other than temporary impairments related mostly to the deterioration in equity markets and to a very lesser extent other than temporary impairments of fixed maturity securities. These were partially offset by net realized gains from the sale of equity and fixed maturity securities. At June 30, 2008 both our bond and equity portfolios were at a slight unrealized loss position. Nearly all of our investments are classified as available for sale and as such the unrealized gains or losses are recorded as a separate component of shareholders equity on the balance sheet.

Unless a decline in value is deemed to be other than temporary and we do not have the intent and ability to hold these securities until its full cost can be recovered. In those cases the securities are written down to fair value and the loss is recorded through the income statement. We consistently have been very conservative in our approach to recognizing impairments.

We continue to have a high quality investment portfolio. Our mortgage-backed securities totaled $4 billion at June 30, 2008 of which about $3.9 billion was in residential mortgage-backed securities and $140 million in commercial mortgage-backed securities. Of the $4 billion in mortgage-backed securities approximately 72% are agency backed. Of the remaining 28% not agency backed, 25% are rated AAA and all but $1.7 million 3% is currently rated investment grade.

Included in these numbers are $202 million of sub-prime mortgage exposure at quarter end. We will continue to manage our portfolio prudently. Note that while we have incurred approximately $0.09 per share of net realized investment losses through the first six months of this year, our full year GAAP earnings per share guidance assumes only $0.06 per share of realized investment losses as we have plans to sell and have sold in the first part of July certain securities during the second half of this year and expect to realize gains on these transactions.

However given our conservative impairment policy particularly in our equity portfolio we could have had more unrealized losses move from the balance sheet through income during the balance of 2008. I’d now like to turn to our reportable segments.

Operating revenue in our commercial segment decreased by $16 million to $9.5 billion in 2Q of 2008 primarily due to the loss of the New York State prescription drug contract and the continued shift in our membership base towards self-funded products. These declines in revenue were partially offset by premium rate increases in all of our medical lines of business. Operating gain in the commercial segment decreased by $108 million or 12% to $821 million primarily due to higher medical costs and membership mix changes in the local group business partially offset by lower general and administrative expenses.

In the consumer segment operating revenue increased by $335 million or 9% to $4.1 billion in the second quarter of 2008 primarily due to premium rate increases in all lines of business and membership gains in our Medicare Advantage products. These increases were partially offset by the conversion of the Connecticut Medicaid business from fully-insured to self-funded, our exit from the Ohio CFC program, and reduced membership in the individual business.

Operating gain in the consumer segment increased by $12 million to $224 million from 2Q 2007 primarily due to an improvement in Medicare supplement and state sponsored operating results. These increases in operating gain were offset by higher benefit expense within our Medicare Advantage business as previously discussed.

In the other segment operating revenue increased by $145 million or 95 to $1.8 billion in 2Q 2008 primarily due to higher premium in the Federal employee plan business as well as revenue generated by our AIM radiology services that we acquired in August, 2007. Operating gain increased by $47 million or 50% to $140 million due to continued profitable growth in our PBM and behavioral health businesses.

Turning now to our claims reserves, medical claims payable were $6.3 billion at the end of the second quarter an increase of $482 million or 8% from year end 2007 while fully-insured membership declined 2%. Medical claims payable declined by $128 million from the first quarter of 2008 reflecting the sequential decline in fully-insured enrollment and a reduction in claims inventories. Days in claims payable as of June 30, 2008 was 47.7 days a decrease of 0.4 days from 48.1 days as of March 31, 2008. This decrease is reflected as follows. We had a one day decrease in claim cycle times which is the length of time between the date of service and the actual claim payment. We had a 0.3 day decrease due to the timing of PBM claim payment, a 0.8 day increase due to prior period reserve adjustments and than all other net to 0.1 day increase.

We have included in our press release a reconciliation and roll forward of our medical claims payable reserves. This disclosure is comparable to the reconciliation provided in our fourth quarter 2007 press release. We report prior year redundancies in order to demonstrate the adequacy and consistency of prior year reserves. For the six months ended June 30, 2008 we again had significant positive prior year reserve development of $270 million.

This level of positive reserve development is lower then the $356 million we experienced for the six months ended June 30, 2007 primarily due to the medical cost trend visibility issues we experienced near the end of 2007 following certain system migrations. However the year-to-date redundancy is in line with the expectations we had as of last quarter’s earning call which validates the efforts we’ve made to regain and improve the visibility into our cost trends.

We continue to establish reserves in a consistent and conservative manner and believe that our June 30 reserves are appropriately stated. Operating cash flow was $1.1 billion for the first six months of 2008 or approximately 0.9x net income. Operating cash flow in the second quarter was unusually low. Some of this is timing related and will reverse to our benefit later this year such as the CMS risk score adjustment payment that was received in July. We also made two estimated federal income tax payments in the quarter and continued to pay down our claims inventories in the quarter evidenced by a 7% drop in our inventories during the quarter.

We have also experienced an increase in self-funded and other accounts receivables this year due to membership growth, claims inventory pay down and actions we have taken in response to our system migration issues and we continue to work aggressively to manage our receivables. Finally our operating cash flow is also being impacted by the decline in fully-insured enrollment. To address this we have numerous strategies in place to grow our fully ensure enrollment in a disciplined manner.

For the year we have lowered our full year outlook for operating cash flow to $3 billion or slightly higher then our projected net income. We strive to utilize our cash flow in a manner that improves shareholder returns. During the quarter we repurchased 16.8 million shares of our common stock for $867 million. On a year-to-date basis through June 30, 2008 we have repurchased 46.5 million shares for $2.9 billion.

At quarter end our remaining Board approved share repurchase authorization totaled $1.4 billion and we expect to execute on most of this authorization by year end. We had $933 million of cash and investments at the parent at June 30, 2008 and we expect our subsidiaries to dividend approximately $2.3 billion to the parent company during the balance of this year.

Long-term debt was $9.8 billion at June 30, 2008 a $727 million from year end 2007 resulting primarily from an increase in long-term borrowings. Our debt to cap ratio was 31.5% at June 30, 2008 and in line with our targeted level.

I would now like to discuss our updated guidance for 2008, as Angela noted our net income is expected to be in the range of $5.42 to $5.57 per share, including net realized investment losses of $0.06 per share. Medical enrollment is expected to be approximately 35.1 million at December 31, 2008, a decline of approximately 150,000 from June 30, [2007] as projected enrollment declines of 205,000 members in the Connecticut Medicaid program will be partially offset by additional growth in the commercial self-funded business.

At December 31, 2008 we expect to have 16.6 million fully insured members and 18.5 million self-funded members. Operating revenue is now expected to total approximately $61.9 billion. As I mentioned earlier the benefit expense ratio is still expected to be in the range of 83.3% to 83.6% and the SG&A expense ratio is now expected to be approximately 14.5%. We are currently developing our three year strategic business plan and while it is too early to provide any explicit guidance for 2009 and beyond I do want to highlight some of the tailwinds and headwinds to earnings that we see for next year.

We have swiftly executed on a number of initiatives this year to address the challenges facing us and this sector. Many of these action steps have been taken in an effort to improve our financial results not only for this year but for next year as well. Let me just take a few minutes to run through a few of what we see as some of the tailwinds.

First we have significantly improved visibility into medical cost trends and collaboration among our business unit. An example of this is the Operations Counsel that Angela highlighted. We believe this process has enhanced our ability to reserve and price more accurately. We achieved our targeting rate increases in most geographies during the second quarter. We are rolling out new products in a number of the coming months to target fully-insured membership growth.

We have adjusted pricing and benefit designs in our Medicare Advantage products for 2009 and we have exited certain state sponsored programs for which we could not achieve actuarially sound reimbursements. We also have some headwinds as we move into next year. We continue to be impacted by a challenging economic environment which is likely to continue pressuring reimbursement levels and state sponsored programs.

A tough economy also impacts commercial revenue and enrollment levels as certain members choose to buy down their benefits or potentially forego health insurance all together. While we have a number of programs in place to introduce more health benefit option and enhance our fully-insured enrollment this is a competitive market and we will remain disciplined in our underwriting. And finally based upon our expected performance in 2008 the criteria for most bonuses are most likely not to be met.

As performance based company we will need to add incentive comps to our 2009 plan to maintain an appropriately motivated workforce. We will provide more details about our 2009 outlook in the future.

We are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Doug Simpson - Merrill Lynch

Doug Simpson - Merrill Lynch

Could you just update us on the systems migration process, I know you’ve put some of that on hold, how are you thinking about that over the next couple years as you’re coming up with your budget and just how does that impact your confidence, what types of swing factors do you put in there for that dynamic?

Wayne DeVeydt

Right now our focus for this year obviously is resolving the previous migrations of which again the host migration is the primarily open one that we’re getting final closure on and we expect that closure by the end of this year. I think the one thing I would say is that prospectively consolidation of systems will still be an imperative for us to become a more efficient company. That being said I think there were clearly some lessons learned over the last year and a half around those migrations and the approach we will take and I do think that standardizing some of the product portfolio that we’re doing today and simplifying some of our processes will not only provide a more smooth transition but in addition to that I think we will bite off a number of migrations on a smaller basis as we move forward.

Angela Braly

Right now we have about almost 85% of our membership is on one of our top six platforms and we do still expect to migrate claims systems but as we talk about standardizing process they are really opportunities for us to standardize certain functionality across the different systems. So it might be a customer facing part of the system, it might be all the claims editing is going to be consistent across the enterprise and then as we do the migration there will be much less risk and it will not affect the customer from the customer facing perspective as we’ve rolled out more consistent processes facing the customers.

So we don’t feel like we’re skipping a beat here, we are looking at the way that the migrations have been executing, as Wayne said learning from those and making sure we have goals about that because ultimately what we want to do is reduce the lights on cost and reinvest those savings in projects that really address cost and quality of health care.

Doug Simpson - Merrill Lynch

The cash flow this year expected to be roughly equal to net income, is that relationship that sort of one to one is that reasonable to expect for the next couple of years?

Wayne DeVeydt

I think the question on that is really going to be driven by how the fully-insured membership continues to evolve. I think when you look at the one to one ratio this year, there are a number of unique drivers but I would clearly expect just from a pure quality of earnings perspective that we should be maintaining at least a one to one ratio relative to that and as we can get our new membership programs, our new products to drive new membership growth you would begin to see that actually move upwards within the one to 1.2 range over time. But again I think as we stabilize the membership base we have a lot of initiatives going out both the second half of this year and early next year, but at a minimum it should be a one to one ratio.

Operator

Your next question comes from the line of John Rex – JP Morgan

John Rex – JP Morgan

Appreciate the commentary on the headwinds, tailwinds as you contemplate 2009 and I just wonder if—understand you don’t guide until the end of the year, not looking for an EPS guidance here but as you take into consideration the economy as it stands today and just making the assumption that it doesn’t improve it doesn’t get any worse but stays where it is, and you think about those headwinds, tailwinds, give me the broad side of the barn in terms of management sense, operating earnings 2009 up down or flat from the 2008 level.

Wayne DeVeydt

We literally will be presenting our three year plan to The Board in the next month and then we’ll be finalizing our operating plan. I don’t want to get ahead of my Board on that. Clearly there are a number of tailwinds that would clearly allow individuals to see significant upside. At the same time we don’t want to minimize some of those headwinds at this point in time. So I’m not trying to be evasive, I just want to be respectful of the process that we have for our Board and for others, but obviously we recognize that a number of things should not repeat next year and we should see improvement in our senior business, our reserves appear to be strengthened, and [inaudible] improved as well. And we continue to execute on our buyback program but again I want to be respectful of our Board.

Angela Braly

As you describe the question initially you talked about expecting things not to really change, that’s why I think we described some of the headwinds that we’re facing. We know that in the state sponsored business there’s some headwinds around state government budgets. We know we have to have actuarially sound rates. We’re assuming that that continues. We’re being appropriately disciplined and focusing on actuarial principals around our pricing because we expect things to continue in terms of a tough economy and a competitive environment.

And the way we win in that environment is we develop new products, we have a very strong brand, we look at places where we can improve the network even more, even though its market leading in most places. We do agree in your original question that there’s some headwinds we’ve been facing and we’re assuming that those are to continue to persist and we’re going to develop new and better ways to meet the customers’ need in that environment.

John Rex – JP Morgan

If it came though would you be startled if operating earnings were down in 2009 given kind of what you know today, would that just be absolutely startling or at this point do you say 50/50 we don’t know.

Wayne DeVeydt

While I don’t want to get ahead of my Board what I would say is this, we are going to take all the appropriate actions including the pricing that we’re filing now for next year and we are making assumptions that trend is not staying flat, we are assuming that trend is going to move up next year. And we are pricing accordingly. How competitors respond in that environment I don’t know and what impact that could have on us I don’t know. What I do know is we’re going to remain disciplined so if people respond in a fashion we expect them to respond our outlook would change but we’ll see how that all evolves at this point in time. We are doing a lot of things that should drive positive growth but nonetheless some of these headwinds are out of our care and custody and we’ve got to see how they evolve.

Operator

Your next question comes from the line of Matthew Borsch - Goldman Sachs

Matthew Borsch - Goldman Sachs

On the commercial fully-insured business, in your remarks you commented on some things that you were seeing in terms of competitor actions, rate guarantees and you listed a couple others, can you give us a little more on that and juxtapose that with your efforts to grow fully-insured enrollment and where you’re having success, maybe what geographies that you think you’ll be successful there and where you think its going to be more of an uphill battle and then just in that context, it looks like your outlook for the back half of the year is that your commercial fully-insured enrollment will be approximately stable, let me know if I got that wrong.

Ken Goulet

I’d like to respond to a couple of things the competitor side and then our own areas of growth, on our own positioning we feel we have really a good advantage overall because of the market share we have in each of our Blue states and I think you know the data, four of our plans have over 40% market share, four over 305, and six over 20%. We had to go through some pricing activity this year to make sure that our pricings were accurate and most of our declines in our fully-insured business was in our non-Blue business where we do not have the same network advantages and where we were doing some price corrections to be able to firm up the business overall. We do anticipate stable through year end and we’ve gotten through most of our rate actions.

Our rate actions did produce slightly higher losses in the west then we anticipated in our forecast but that we held disciplined in our pricing and it was only slightly greater. Our growth is more in the northeast with our Prism product which was newly rolled out and the Prism product has been a very good product. We feel that we are comfortable where we are. We have some fairly significant new benefits going out in California with three new products rolling out in the third quarter and in the southeast we have new products rolling through and have a much more disciplined and robust annual benefit change process going into place into all of our areas.

On the competitive front I would say rational but aggressive—the rate caps in other areas are primarily from local competitors rather then from the national competitors and they’re doing that essentially to offset some of the advantages that we have so when you see a premium holiday I do not see that from any of the national competitors but we do see it from some of the local competitors to try to offset our advantages and make a buyer look at a one year buying decision rather then a long-term buying decision. We feel that we had the majority of our rate changes going forward we’re excited about the product enrollment enhancements we have. They are rolling out across different areas of the country. But feel pretty comfortable for year end.

Angela Braly

In terms of fully-insured membership we are seeing the declines at slightly more then we expected and we’re projecting more particularly in UniCare then we had originally projected but one thing that’s really positive is we’re looking at the active cancelled loss ratios for the fully-insured book and its actually much more positive then we had expected before so we are keeping good members and healthy lives that we had been concerned about in the past but our active and cancelled loss ratios are looking better then we had thought.

Brian Sassi

That is true, in our individual book of business we’re actually having the best sales year that we’ve had in our history. That is being partially mitigated by higher then anticipated lapses which are really driven by two factors. One is the economy and two is some of the competitive rating pressures but we are essentially our outlook for the remainder of the year is stability in terms of membership from both individual and senior business.

Operator

Your next question comes from the line of Justin Lake – UBS

Justin Lake – UBS

In regards to thinking about pieces to 2009 and I realize the economy is the big wildcard and certainly don’t want to ask you to make a projection there, but as I think about the margins for the business should be—are something that I think would be much closer to your control and something that is certainly being debated around throughout the industry as just the whole underwriting cycle and what the margin trajectory of the business really is, given all you’ve talked about with the re-pricing actions given that you’ve actually had the experience now of putting through these big rate increases and how the market accepted them in a tough economy, what you’ve actually been able to do in Medicare Advantage as far as changing your benefit designs for 2009, while I understand the economy being a wildcard to plus minus can you at least to talk to kind of what’s under your control on a margin side and do you think that there’s something you could talk to as far as the margins for next year and whether you think there’ll be some improvement because when you think about the net headwinds, tailwinds especially the underwriting margins.

Angela Braly

I think what we’re going to continue to focus on our three year plan and our annual planning process and be in a position later to give better guidance on that. You brought up a couple of actions though around how we have re-priced, we’re seeing those go through, the rate actions are holding, and we did change the Medicare Advantage. In terms of expectations in 2009 the bids are in, we don’t know where we stand relative to that.

Brian Sassi

Can’t really talk to specifics on the bids, the bids are in and we’re expecting to hear back next month relative to that. But we are expecting improvement in operating margin as a result of plan changes and some of the plans that we’re experiencing higher then expected losses on this year. We did not re-file in specific geographies. So I think those two actions will result in underwriting improvement in our senior line of business.

Wayne DeVeydt

Our active versus cancelled loss ratios even after these recent rate increases are looking positive and so those are the indicators of clearly being able to continue that trend and get appropriate margin expansion but as we’ve said we’re pricing with discipline for next year. We hope others will maintain that same level of discipline but if that isn’t there obviously that will impact ultimate op gain if we have to suffer another year of membership attrition and again we’re not going to go chase this business. We are going to maintain our margins and continue to try to find ways to expand those margins through G&A efficiencies.

Justin Lake – UBS

On the commercial pricing side, is there anything more that you can give us, you talked about California for instance being a place where you put through some pretty big increases and we’ve heard the [inaudible] numbers and is there anything you can talk about as far as what kind of attrition you normally see in a year versus what you’re seeing now and how that was versus your expectations, just put some numbers around it so we can think about that from a total book perspective.

Ken Goulet

We had as you know as we went into the year we had adjustments in pricing across the board and in different geographies. In California we did increase more in our consumer driven plans and the losses were modestly more then what we had forecasted when we did our March forecast and our restatements. It’s pretty much trending like it does annually. We have right before our [inaudible] renewals we have activity first where we have our biggest month of increases and then we have our lowest month of sales. That occurred as it annually does occur but what happened was with the rate increase since we had anticipated a little more attrition then normal it is more then it was last year but only modestly higher then we had projected but that is the one area where there was more losses then what we had put into our recovery plan.

Justin Lake – UBS

Can you just put a number around that, if the attrition is 20% previously is it 30% now?

Ken Goulet

We really don’t provide on a state specific basis. It’s difficult to say but all I would say is its very modest, based on size of book, very modest.

Justin Lake – UBS

So less then 5%, greater?

Ken Goulet

It would be less then 5%, correct.

Operator

Your next question comes from the line of Charles Boorady - Citi

Charles Boorady – Citi

By how many points is the Medicare Advantage book now below your target? I recognize you don’t provide loss ratios, can you at least tell us the number of percentage points below your target you’re at with MA, sounds like its deteriorating a bit more then expected and then how you’ll achieve the tailwind from MA in 2009. You talked about the pricing of benefit decisions but how is that going to manifest itself in 2009 in terms of likely drop in enrollment that might result and likely improvement you think you can achieve in the overall profitability next year.

Wayne DeVeydt

As you know we don’t obviously provide specific details by product, what I will say at this point though is that the net advantage has deteriorated slightly more then we thought partially because we added a number of members in those particular products that we were having issues with in the second quarter about 30,000 members or so. And so one of the things is we expect the continued deterioration of that through the second half of the year.

That being said, one of the concerns we had going into next year was whether we could make all the appropriate benefit changes on certain products and as Brian mentioned we actually made a conscious decision not to renew those products at all, we actually did not resubmit those products and so one of the reasons is that we expect to see obviously some positive tailwinds there is that it is those particular products that we are having our issues with. It’s not the broader Medicare Advantage program in and of itself.

Brian Sassi

From an enrollment standpoint we’re likely to see a modest decline as a result of not re-filing some of the enhanced plans in select geographies. Additionally we made benefit changes to some of the non-enhanced plans and the sum total of those two changes we’re expecting to reflect in increased operating gain. We expect to continue to be very well positioned in the Part D segment in 2009 also.

Charles Boorady – Citi

Can you give us any numbers at all or just rough numbers like is most of your book at your target level of profitability but you’re losing money in enhanced or is your whole book below your target level of profitability.

Brian Sassi

The entire book is not below our target profitability it is in select product designs which we have addressed in the 2009 bid process.

Charles Boorady – Citi

So will dropping enhanced get you to your target level of profitability next year?

Brian Sassi

That’s what we’re projecting.

Charles Boorady – Citi

How many basis points below your target are you on the book, or how much higher is your loss ratio overall then you target?

Brian Sassi

We don’t share loss ratios by product.

Wayne DeVeydt

Consolidated it’s about 45 bps but again we don’t do it at a product level.

Charles Boorady – Citi

It contributed 45 bps to the increase year-over-year?

Wayne DeVeydt

Yes.

Operator

Your next question comes from the line of Joshua Raskin - Lehman Brothers

Joshua Raskin - Lehman Brothers

Just want to clarify on the cost trends, just looking at the press release the 90 basis points in terms of the year-over-year impact, that’s the same impact that we saw in the first quarter and the reason the MLR was up last year-over-year in the second quarter versus the first quarter was mainly because you saw a little bit of improvement on the MA side?

Wayne DeVeydt

Couple of things, obviously we’ve written a lot more Med Part D this year then we did the previous year and remember our seasonality patterns there because of the product designs we had actually put even more MLR downside pressure on the MLR in the first quarter and we’re seeing that online in the second quarter so while overall Medicare Advantage isn’t necessarily improving the Med Part D seasonality is starting to come through and we’re seeing those improvements and that’s actually doing well for us at this point in time. So that’s one of the drivers in that year-over-year comparison and quarter-over-quarter.

Joshua Raskin - Lehman Brothers

But obviously nothing on the commercial side that you saw nothing got worse on any of that?

Wayne DeVeydt

No commercial is actually slightly better then our expectations and we think the eight plus or minus 50 basis points is very good but I will say that while we think it appears the trends have stabilized we are assuming for pricing next year a rising trend.

Joshua Raskin - Lehman Brothers

In the press release you also talked about account retention programs, and then I saw broker incentives, what exactly are account retention programs, is that done from a pricing perspective or are there other service type of guarantees and improvements you’re making.

Brian Sassi

There are a number of things that we’ve put in place in both our individual and we’re also beginning to leverage it in our senior book of business where we’re actually making outreach calls to members that have indicated a desire to cancel and our early returns in the last six months are that we’re retaining 70% to 80% of the people that we actually contact into plans so that’s a successful program. As well as we’ve implemented health plan advisors in a number of our geographies and they really are higher level people, very familiar with different plan designs to really assist members instead of dropping coverage, moving to a more appropriately priced product for what they’re looking for.

Ken Goulet

And with the employer group or the commercial side we’ve instituted in national accounts and many of our large group areas a process called the WAR room or Winning at Renewal where we are reviewing all aspects of an account before going out to make sure we’ve being consultative in our approach to looking at alternatives to meet the client needs and it is helping in our overall approach to being a consultative partner to the customers, pricing appropriately, finding the right margins but also working together to find the right approach and the WAR room has helped our overall activity.

We’ve also done some very detailed pricing analysis across all lines of business and as mentioned earlier our active cancelled ratios are in the positive and we have spent a lot of time looking at where we need to make sure we always hold the line and where we can be flexible on some more cases that are running very well. We’ve started to roll that out across more and more geographies.

Operator

Your next question comes from the line of Scott Fidel - Deutsche Bank

Scott Fidel - Deutsche Bank

Just wondering if you could elaborate a bit more just on the outlook for the early read for 2009 medical cost trends and I know you said you’re assuming a bit of an uptick, if you could talk about the magnitude of that and then just looking at the individual components maybe where you see the most risks to acceleration and then areas where you can potentially see some improvement in 2009 relative to 2008.

Wayne DeVeydt

For competitive reasons obviously we don’t typically talk about the level of increase but I’ll try to give you some overviews and again this will vary by geography and by product but what I would say is we are assuming in our pricing the trend will be moving upwards and probably the best way to describe it at a competitive level is I know that one public competitor has already discussed the level and I would say that level is very reasonable. It’s probably the best way for me to describe it regarding overall upward trends that we may be expecting. That being said there are a number of things that could impact that and one of the items that could actually put downward pressure on that trend really is going to be mix shift in the business and how that evolves.

So for example if we continue to see more higher deductible products more within the CDHP programs and that evolve that actually can actually drive down the pay trends even more then what we thought underlying trend would be. So one of the items that could be distorting to the trend numbers could actually be the mix shift and it could actually show what might be a favorable trend but its more of a mix shift more then underlying trend itself. So one of the things we are doing though is when we price for next year as we look at what we believe core underlying trend is and we price for that and then we modify it based on the actually products in the mix shift versus using mix shift in that pricing decision upfront.

We actually do it on the backend so I think that’s one item that could clearly impact it. The other thing is we do price so that our [premium yields] do include total medical costs trends and again that includes SG&A as well and then obviously try to leverage our SG&A accordingly.

Scott Fidel - Deutsche Bank

I know that one competitor which I think had cited a 50 bps increase expectation for next year they had also just talked about seeing some increases in their behavioral costs just relative to utilization which they thought might be economic related and just given that you have a pretty big behavioral book, if you can talk about what you’re seeing around costs in the behavioral business at this point.

Wayne DeVeydt

We’re not necessarily—the economy doesn’t usually appear to have a major driver on the behavioral utilization at least in 2008. There’s often a lag though during economic downturns and there’s more use after job loss when individuals are experiencing stress in the workplace so we’re obviously taking that into consideration though as we look to our pricing for next year but as it relates to 2008 we’re not necessarily seeing those behaviors changing. Also the effects of the Timothy Law in New York, those were largely felt in 2007 and those were incorporated into our 2008 trends in pricing so I think we’ve got a relatively good baseline for that.

Operator

Your next question comes from the line of Peter Costa - FTN Midwest Securities

Peter Costa - FTN Midwest Securities

You’ve taken another $220 million charge to equity for your portfolio is there anything in there that’s not paying dividends currently and then on your inpatient prices mostly but costs overall you said it went from upper single-digits last quarter to low double-digit this quarter, is that more out of network costs or that more higher prices at negotiated rates in your Blue markets or is that something else or is it the non-specific volume of large claims that you talked about in the first quarter?

Wayne DeVeydt

Let me start with the latter part, again its 95% of it is really is unit cost at this point in time and something we continue to look at on our contracting. In terms of the portfolio we do have under 10%, I don’t have the exact percent in front of me, I know its south of 10% in terms of equity and while some of those equity portfolio is paying a dividend a substantial portion of it is in dividend paying and again its part of our policy just to remind you how we treat equity, if an equity is underwater by $1.00 after 12 months we will write that down. And in addition take that through our P&L.

And if its underwater by 20% in six months we will write that down to that value even though we haven’t sold the underlying assets so a big part of what you’re seeing there is within the equity portfolio and obviously we’ll file our 10-Q today and I think when you look at that, you’ll see that the vast majority of that impact for unrealized losses that we’ve run through the P&L as well as the pressure you’ve seen on the overall reduction for the unrealized gain loss position is coming from the equity portfolio and what’s happening in the current equity markets.

Peter Costa - FTN Midwest Securities

I was actually talking about what didn’t run through the P&L, what went straight to the equity line.

Wayne DeVeydt

Well again, you’ll see the unrealized gains and losses being again almost primarily driven by the equity portfolio as well. So for the assets we still hold that haven’t met that criteria we are marking to market those every month and every quarter. So as the markets slide down and as we’ve all seen with the dollar lose almost 2,000 points just in the last three months, that impact does run directly through our equity as an unrealized loss or said differently, many of those were in an unrealized gain position and that gain has come down substantially so if you actually look at our total portfolio its in a very slight loss position but again that’s more market based timing and as we all know if the market starts to turn around and recover that will shift back to a positive number in the next quarter.

Peter Costa - FTN Midwest Securities

You did say it was price on the hospital side of things, you didn’t say whether that was out of network prices that are higher or is that in network prices that are higher.

Angela Braly

It’s likely both. We’re saying 85% is really driven by unit costs or 95% in terms of inpatient and it could be both. We’re addressing unit costs and utilization focused on our contracting, our medical clinical management. We’ve put some specific focus around nicu and oncology because we saw those as drivers early in the year and so we’re looking carefully and working on programs around that as well.

Wayne DeVeydt

It’s mostly in network.

Operator

Your next question comes from the line of Carl McDonald - Oppenheimer

Carl McDonald – Oppenheimer

In the past you’ve talked about not just pricing to trend in 2009 but trying to make up at least a portion of the 90 basis points of mispricing this year, is that still your intent for next year?

Wayne DeVeydt

We’re obviously in areas where we believe we can make up for that delta and appropriately price without having attrition that would cause active loss cancelled ratios to be distorted. We’re obviously trying to bake that into pricing. In other areas where it is extremely competitive we will not be able to get that full 90 basis points, we recognize that without having a negative impact, we think to the broader company and so we are looking at that very strategically by market so but I don’t want anybody to assume that there’s going to be an additional 90 basis points tacked onto pricing on an enterprise wide basis, that is not the case.

Ken Goulet

That’s something that over time will work back, but you cannot do a one-time increase to recover or else your trend increases are different then other carriers and it will drive more looking at alternatives so we balance it appropriately according to how well we are positioned in each market. But it’s something that we’ll earn back over time.

Carl McDonald – Oppenheimer

We’ve heard from both Aetna and WellPoint in the last month or so that they really haven’t seen competitors doing any kind of material increase in pricing for 2009 relative to the rate increases this year, is that consistent with what you’ve seen overall?

Ken Goulet

We’re seeing rational pricing. We are sensing that pricing is continuing to firm up in certain areas. I think that others will see where our pricing has made changes and where we’ve recovered in certain areas but I think it’s safe to say that it’s consistent with prior years but I do believe I am seeing others recognize a slight increase in trend for next year as well.

Carl McDonald – Oppenheimer

When do we actually get into the heart of the January 1, 2009 full risk renewal season?

Ken Goulet

The full risk renewal season is believe or not, not until last quarter and literally into the for a small group, into the November, December timeframe. It really is finalized during the last portion of the year. The ASO is well into it right now, but its all last quarter. We’ve done some large group renewals at this point and we’ve also had some large group sales activity for 01/01 of next year. We captured a pretty nice $23,000 life fully-insured case but the general, the majority of what we do is in the last quarter.

Operator

Your final question comes from the line of Mike Baker – Raymond James

Mike Baker – Raymond James

On the unit cost trends on the inpatient side, have you seen any change in coding intensity by hospitals contributing to that?

Wayne DeVeydt

You know I can’t say that we’ve seen that necessarily happening although I will tell you that our medical management group is continuing to evaluate bundling that may or may not be happening and how they’re applying some of those DRG codes and CBT that they’re doing there but I don’t think we’re really seeing that at this point.

Ken Goulet

No, there’s one area that we didn’t bring up earlier, there is the hospital consolidator in the west who is purchasing hospitals and immediately dropping out of network of all carriers to try to—so we do see a slight increase there of out of network in the west. That is being legally challenged not through ourselves but through the government and other areas. It’s being looked at so that’s where I’ve seen the most significant change. But in hospital intensity I think it’s consistent with what it has been in the past and have not seen a significant change.

Angela Braly

As we rollout and have consistent claims editing processes on our side we can really start to see where there’s variation across the country and then target our cost of care and management activities towards places where we’re seeing variation. So it’s going to be a powerful thing.

I really do appreciate and thank you for your questions. In closing I want you to know that we are responding aggressively to help ensure achievement of our goals and this includes implementing actuarially sound rate actions and executing on cost optimization opportunities to achieve our financial objectives. We’re introducing innovative products to improve our competitive positioning. Our leadership team is in place. We’re gaining traction and we’re executing on our growth initiatives, product development, simplification plans, specialty integration strategies, and we’re driving for sustainable long-term results. I want to thank you all for participating on the call this morning.

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