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Executives

Drew Asher - Sr. VP, Corporate Finance

Dale B. Wolf - CEO

Shawn M. Guertin - EVP and CFO

Analysts

Josh Raskin - Lehman Brothers

Charles Boorady - Citigroup Smith Barney

Thomas Carroll - Stifel Nicolaus

Scott Fidel - Deutsche Bank

Matthew Borsch - Goldman Sachs

Doug Simpson - Merrill Lynch

Michael Baker - Raymond James & Associates

Carl McDonald - Oppenheimer & Company

Justin Lake - UBS Securities

Matt Perry - Wachovia Securities

John Rex - JPMorgan

Coventry Health Care, Inc. (CVH) Q2 FY08 Earnings Call July 25, 2008 8:30 AM ET

Operator

Good morning and welcome to Coventry Health Care's Second Quarter 2008 Earnings Conference Call. Today's conference is being recorded and all participants are in a listen-only mode. Today's call will begin with opening remarks by the Chief Executive Officer of Coventry Health Care, Mr. Dale Wolf after a brief forward-looking statements read by Drew Asher. Please go a head Mr. Asher.

Drew Asher - Senior Vice President, Corporate Finance

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 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?

Dale B. Wolf - Chief Executive Officer

Good morning everyone. As you have seen, this morning we reported operating revenues of almost of $3 billion for the second quarter, up 27 plus percent over the prior year and net income of a little over $83 million. I think these result are as expected and consistent with our updated guidance a month or so ago. Our guidance for the remainder of the year is also completely unchanged and Shawn will elaborate further in his remarks.

Before that, I just want to touch on a couple of things. First, growth across our business lines. At the beginning year, we identified four areas that were critical to our growth in 2008, including small group, individual, Medicare and comp.

You can see for the quarter, we actually grew across most lines of our business and certainly including the four mentioned here. Year-to-date, our small group membership is up almost 3%, individual lives are up 19%, Medicare lives including Part D are up 26% and our workers comp revenue was up 9% sequentially and far more than that year-over-year, due to last year's acquisition. While there have certainly been pluses and minuses across these relative to our expectations, buy and large they are doing very well, and leading the growth effort in the company.

On the flip side, you have heard us about our disappointment and not winning some new Medicaid contracts and I won't belabor that. But the real disappointment and impact in terms of growth has been our commercial risk business. I know that's a situation not unique to us, but it has been disappointing.

You'll quickly deduce, and as much as our small group business is doing very well that this an issue around large group, somewhat weighted towards customers retention. We need to better there and are working on several of initiatives to do so. But stepping back from these specific line comments, I want to make sure we keep our growth in context.

Overall our current guidance would have revenue up in excess of 20% for the year and more than 10% of that is on the organic side. So we feel like our organic initiatives and acquisition efforts are actually working pretty very well.

Second, I want to remind you that we're continuing to work on introducing specialty products to our customers, since our acquisition in February of Monet, a behavioral health company. We've further plans to in-source that capability across our markets. So far, we're in the process of rolling out that to three of our health plans this year. We will implement five more in the first half of 2009 and the balance will go live, January of '10.

We're also finalizing our plans to rollout life and dental products for January 1 sales. While our expectations are modest across all of these in terms of our financials in '09, there is substantial activity going on and we continue to believe these will be meaningful increments to our growth over the next several years.

Third and lastly, I will talk a little bit about our Medicare strategy, certainly including H.R. 6331, which has a direct bearing on private fee.

Overall, we are once gain experiencing significant growth in 2008, both in our coordinated care products and private fee per service as well as Part D. We now cover almost a 1.25 million seniors; 372,000 of those in Medicare Advantage and 874,000 in Part D. Overall, this represents about 33% of our company's revenues.

Today we have coordinated care products in 13 metropolitan markets, with plans to add nine additional markets for 2009. And these states, where we will and do have coordinated care offerings, now cover 58% of our private fee for service membership, representing about 142,000 out of the 241. An additional 11 states that we've identified capture another 26% of that existing membership and we are in the process of developing networks in those states.

Now that we have query around timing of the direction, we really did anticipate, it feels like we have sufficient time to deal with the small remainder in whatever way it makes the most sense, somewhat depending on the forthcoming regulations.

While this year is obviously shaping up to be less than what we had hoped, the fundamental drivers of out business growth remain very good. And as you have heard me say before, our market position by segment, those areas we focus on, feel like much the right place to be.

We certainly need to keep all of these things going. We need to improve our results in our commercial risk business relative to growth. And we need to make sure of course that we are in front of our cost trends with our pricing, which we are absolutely committed to be and Shawn will spend more time on this latter area.

And now let me turn it over to Shawn for his color.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Thank you, Dale and good morning everyone. As you have heard, our overall results were consistent with the expectations we shared with you in June and we are pleased to reiterate our earnings outlook for full year 2008.

While earlier events dictate that most of my discussion will focus on the two major items creating strength in our 2008 performance, it is important to realize that we continue to experience strong performance in many areas of the company, notably Part D, Medicare HMO; Medicaid HMO and our specialty businesses.

In additional, within the commercial business, we continue to post organic growth in the market segments we find most attractive, individual and small group. So while I will spend the bulk of my time on the two items we have discussed last month, the commercial medical loss ratio and the Medicare Private Fee-for-Service business, it is important to remember the strength and performance in many other areas of the company.

I'll start off with the commercial MLR. This has played out in the second quarter entirely consistent with what we shared with you in June. At a high level, we have some initial visibility into the developing claim payments related to the month of April and May at this point. The good news here is that April and May would indicate that medical cost trends and its corresponding impact on the MLR, is not accelerating.

Having said that, there doesn't appear to be clear and convincing evident yet that it is abating either. Both physician and pharmacy trends continue to look just fine, so at the end of that day this continues to be an issue driven by facility trends. On the in-patient side, this continues to be a unit cost issue, driven in particular by an up tick in claim severity.

Unlike other severity-related spikes that I have seen in the past, this appears more broad based than it is focused in terms of both geography and claim type. While this is certainly more pronounced in certain health plan markets, more than half of our plans are experiencing this type of trend pressure.

Looking at the type of admission, it also indicates this more broad based aspect as well. We are seeing pressure in three of the top five diagnoses categories related to in-patient admissions. We can clearly identify where this is happening and where it is not, and we have been able to rule out... rule some things out. But we will keep analyzing to get a deeper understanding of the whys behind this issue.

On the out-patient side, the global story here similar to in-patient, from the perspective that this is broader based than focused in terms of both geography and type of service. Unlike in-patient, there are more elements of utilization pressure here, as well as some elements of unit cost pressure.

Out-patient is a fairly broad category of services that aren't exactly homogeneous. So on a call like this, it's a little difficult to generalize, but we can see a few patterns emerging here. One is that there is some smoke around coding issues, for example. We're looking into coding and billing on ER claims, where we're seeing an unusually high number of claims coded at the highest complexity levels.

Chemotherapy and related drugs are another area we're investigating, as well as it pertains to coding and billing. In certain plans we are also seeing new patterns of care being used for certain situations that involve new or increased use of high-tech procedures, inject able drugs et cetera.

So, as I mentioned earlier, we are getting more and more answers as to the whys behind all of this. as we identify the drivers to the extent possible, we will be putting in place strategies around medical management, contracting, audit and benefit plan design.

But the most relevant aspect of this discussion revolves around the pricing action we are taking in response to this. To no surprise, that while the analytic process around this will continue 24/7 for the foreseeable future, we are not sitting on the sidelines and so we have every answer.

Our long-held pricing philosophy is to price at least equal to expected medical cost trend and we will continue to that by assuming that this higher level of trend that we have experienced in the first half of 2008 will continue into 2009.

In addition, a standard part of our process has been and will continue to be; that we add some margin to this estimate as a hedge against any further deterioration in trends and we have built this into our 2009 pricing actions as well. It is still early in the process, in much of the 2009 pricing cycle as well as the trend story needs to play out before we can provide refined guidance as to what all this means to the 2009 commercial MLR.

However, I would point out that our multiyear earnings growth formula has been premised on having a stable commercial MLR from year-to-year. So I can tell you that achieving at least this outcome for 2009, with a large factor in the thinking about how hard to push on price.

Let me now turn to Medicare Private Fee-for-Service. The story related to prior-year reserve development is unchanged from June. As we told you then, we've experienced approximately $50 million of unfavorable reserve development year-to-date, the majority of which was experienced in April and May, and that is still the situation as of the end of the second quarter.

As you have seen in the press release, the total Medicare Advantage MLR for the quarter is a little higher than the range we estimated in June. The driver here is the decision to continue taking a prudent approach in booking current year expense based on what we observed in the June paid claims. The big picture story here is still the same.

The Medicare Private Fee-for-Service business still a fundamentally sound and profitable product, expected to produce a run-rate medical loss ratio in the high 80s for 2008. When combined with the Medicare Advantage HMO MLR in the low 80s, this results in a run rate MLR in the mid 80s for Medicare Advantage in total.

I did want to also to touch on a few other items. The first is cash flow from operations for the quarter. I believe the drivers here may be understood, as I know this has come up on previous earnings calls this quarter. As always there many moving parts here, but the single biggest driver in the quarter and the year for that matter is related to tax payments.

Specifically in the second quarter, we make two federal tax payments. The effect of these two payments was a strain to the cash flow statement of approximately $115 million in the quarter. As you can see, after adjusting for this, the cash flow picture for is Q2 quite strong.

I'd also like to provide a little insight on days in claims payable for the quarter, as well. The takeaway here is that as computed and represented in the press release, it appears down about one day for the quarter. But when you look behind it and cut away some of the noise that is actually going up versus last quarter.

The first item here is fairly easy to understand and is related to our exit from the Pennsylvania Behavioral Health Medicaid Contract as of the end of this quarter. You'll recall that this was a capitates pass-through arrangement we had with a local provider group. As part of this arrangement, we withheld funds and maintained certain medical liabilities related to claim payment and risk sharing that were established over the course of many years. As part of the termination of the arrangement, these funds along with any related liability were returned to the provider group. The return of these funds doesn't hit the income statement, but does cause the corresponding liability to decrease and a corresponding drop in the DCP of 1.7 days in the quarter.

The other item has to do with all the moving parts in private fee-for-service this quarter. The short story here is that, with although the prior-period paid claim expense recognized in the current quarter, this metric is artificially depressed because of the have incurred expense on the income statement is inflated above normal levels. This situation depress the DCP by about a day in the current quarter.

An alternative advantage point on this is to recognize that the Private Fee-for-Service IBNR on an apples-to-apples basis verses last quarter is up over $50 million in absolute terms and up around 20% on a per-member basis.

In the area capital uses and plans, you can see that we paid off a $190 million on our revolving credit facility, consistent with our previous de-levering commitments to do so, by the end of the second quarter. During the second quarter, we repurchased one million shares and I am very pleased to report that so far in the third quarter, we have repurchased an additional 3.1 million shares bringing the year-to-date total repurchase activity to 7.3 million shares.

We are certainly committed to additional buybacks in the second half of the year, given current valuations and our guidance assumes, we will deploy the balance of our remaining free cash to share repurchase during the balance of 2008.

So, in closing, I'd summarize by saying that, we have our arms around and are on track regarding both of the items we discussed last month. In addition, in many areas of the company, we have implemented strategies to fuel growth now and into the future, and the performance in this many areas is very good. And perhaps, most importantly, we are fully committed to taking the necessary pricing action on commercial as a key piece of the plan to get back on an acceptable earnings growth trajectory in 2009 and beyond.

This concludes my prepared remarks. Operator, we will now open up the call for questions. Operator?

Question And Answer

Operator

Yes thank you. The question-and-answer session will be conducted electronically. [Operator Instructions]. And we will take our first question Josh Raskin with Lehman Brothers.

Josh Raskin - Lehman Brothers

Good morning. Two questions for you; one, on the MLR on the Medicare, you said the Medicare Advantage sort of came in, I think you said a little bit higher than you were expecting in June, the updates a month ago. So, I am not sure I heard what the driver was for that.

And then your second question, Dale said that you guys got do better a job and retention of large group commercial; just curious what that means? What sort of initiatives then, is it really that bad to see some of these large groups Dale?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

I'll take the first one, and I'll let Dale do the second one. Josh as you'd suspect given earlier events, we are doing everything in our power to pay private fee-for-service claims as promptly as we can. And to no surprise our customer service organization is succeeding at this and so the average cycle time is decreasing steadily.

When cycle times are decreasing, most IBNR models tend to over project incurred claims for a period until cycle times stabilize. And given where we've been on private fee-for-service, we've just let this be, even though we can clearly see we are clearly decreasing claim payment cycle time.

Josh Raskin - Lehman Brothers

Okay. It's all of the private fee-for- service.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Yeah, absolutely 100%.

Josh Raskin - Lehman Brothers

Okay thanks.

Dale B. Wolf - Chief Executive Officer

Josh, on the second one, there is a million stories like in most of these, but let me tick a few of them off. Obviously, there are number of reasons and by the way, when we talk about large group, let's put this in context right, large group for us is anything other than small group and small group is 1 to 50. So there are wide range of customer levels within what we call a large group.

But there are some dynamics there that won't surprise you and that are seen across the industry. Less so right now, but certainly over the past two years, one of the dynamics has been consolidation of carriers. And we've certainly and notably in the last couple Januarys lost a number of pieces of business to that consolidation, whether it be most of the time on a self-funded basis, but occasionally we have an ensured piece that ends up going self-funded with the national consolidation.

Second dynamic has to do with conversion to self-funded. There have certainly been examples of attractive pieces of business that we have lost as they have converted to self-funded. I actually don't think we should lose those. We ought to win the self-funded piece and that's the one of things we are trying to improve the result on.

The third thing is that we should, in my view, never lose a self-funded customers that we have already. We have the case installed. We are providing the service, our service has been outstanding and so we are working to make sure we don't lose any of those self-funded customers.

And then there are a variety of sort of very... and some of those that I have to mentioned. Arguably when a case consolidates and if we don't have an opportunity at the national business, I mean that is what it is and there is nothing we can do. But there are a number of things we can do better internally. It's the full and very operational stuff about how you account manage the quality of people, the incentive programs you have in place, the focus you put on it and on and on down the line. And we have a full blown plan about how to do a better job there that includes all of that more.

Josh Raskin - Lehman Brothers

That's very helpful, and I am sorry Dale to just sneak one more in. PBM update sounds like the decision has taken a little bit longer than you had expected?

Dale B. Wolf - Chief Executive Officer

No actually, that is done and out. We didn't actually announce anything, because it wasn't necessary. But we have made a decision to move our Medicare business, to Medco effective January 1, 2009. You remember, we sort of had a split contract. Our Medicare business was up 11/09 and our commercial 11/10. And I believe that Medco has made that announcement.

Josh Raskin - Lehman Brothers

Thanks.

Operator

[Operator Instructions]. And we will take our next question form Mr. Charles Boorady, with Citi.

Charles Boorady - Citigroup Smith Barney

Thanks. Good morning. On the commercial risk business, can you remind us the pattern of renewals. What percent of business renews when... and for July 1. In particular what are you seeing this month in terms of yields on renewals and attrition from customers, who may not be able to tolerate the rate increases that you are pushing through?

Dale B. Wolf - Chief Executive Officer

Its roughly Charles, 50 I am going to go Q1-Q4. 50 the 50-15, 20-15 roughly, sort of by quarter and you can see actually that we actually got a little tick up in yield this quarter, compared to last quarter and that attempts, that really hasn't been an offshoot to sort of the pricing that we've put in place that probably has more to do with a higher mix of small group than large group kind of coming up first quarter.

And so far, new business sales when you look at it kind of looking forward which is the most important part of this seem pretty good and comparable to last year. And so far we have not seen a persistency, actually in the contrary in some of the smaller ends of the market persistences are ahead or better than it was a year ago.

Like I said, we are still in a relatively early period in sort of the '09 pricing cycle. But I would say pricing is still fine in new business and persistency likewise the self line.

Charles Boorady - Citigroup Smith Barney

The comments you made on pricing for '09; does that start to take effect immediately that was your price in July 1 renewals?

Dale B. Wolf - Chief Executive Officer

Well, yes but July 1 was long gone I mean before but yes, so we will touch the end of '08 on the smaller cases, and some of the large cases, and then some of '09. So that has been effected and implemented, but a simplistic way to think about it is we are probably not pushing that in math sort of until the fourth quarter.

Charles Boorady - Citigroup Smith Barney

I see... was it sort of too late for third quarter renewals, when you realized that you needed to take this pricing action?

Dale B. Wolf - Chief Executive Officer

Not every single market. Different markets have differently lead times. So, we did catch some of... this has gone in on small group for example in the third quarter. Probably, in general, it was late for the large group.

Charles Boorady - Citigroup Smith Barney

And...

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Charles, just to add one thing, don't forget there were two prices of this. We did our initial pricing action back in March. It may have caught more of third quarter. But, this latest round of pricing action that went it in the last month, probably caught almost none of the third quarter.

Charles Boorady - Citigroup Smith Barney

So what's the average yield?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

I don't understand your question.

Charles Boorady - Citigroup Smith Barney

The average yield you are achieving on price increases that you're putting through to renewals; the percent increase that you are realizing on renewed business?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Well at this point, I can tell you that, we have pushed harder than the trend increase that we've seen sort of on top of our pricing. So, again I am not exactly sure still what your question is. We've been realizing on the income statement. We've mix and everything else; yields in the mid to high 4s. And so, again all other things being equal, you are going to see... you are going to hopefully see a push above that.

Charles Boorady - Citigroup Smith Barney

Got it. On the cost side one area that sounds concerning and pervasive is around these coding issues and coding intensity. Are you hearing from consultants who work with hospitals that there is industry-wide trend or you think this is Coventry specific issue. What you think is causing it and why this year?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Well, I can't comment from...

Dale B. Wolf - Chief Executive Officer

I think Charles there is a few drivers on this. But some of that is the normal cat and mouse revenue game that we have always played with facilities. And so, how some of these higher cost drugs, implantable devices and things like that are sort of coded and billed and reimbursed is I would say sort of something that's been in the works for a while. But again, I can't foresee sort of go back and prove this to repeat.

But as MSBRG is one in at the end of the last year. There was a fair amount of activity to make sure that facilities appropriately coded their claim, so that are particular implementation get in sort of hurt their revenue cycle and I think they coded things one way, whether it's Medicare or commercial. And so that is one thing that I thing was sort of going on last year. I think that would be very plausible to say that that sort of has created maybe some broader base. but I would also say that I think some of this is maybe just the normal part of what we sort of go through all the time, with sort of revenue maximization and again sort of the cat and mouse game we always play around this.

Charles Boorady - Citigroup Smith Barney

Was there a change in your systems or in your way of contracting with some of these?

Dale B. Wolf - Chief Executive Officer

No, not in any meaningful way.

Charles Boorady - Citigroup Smith Barney

Thanks.

Operator

: Thank you. We will take our next call from Tom Carroll with Stifel Nicolaus.

Thomas Carroll - Stifel Nicolaus

Hey, good morning. Just a quick follow up on Charles' question about the facility component of the trend. Shawn, you mentioned that severity was driving it up and your response to Charles, it sounds likes it was more of a mix in kind of price and severity, and kind of the same stuff you have been seeing. Just wanted to confirm that, is it... is severity not the key driver or is just sounds like you back off that a little bit.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

No, no. On in-patient it is the predominant issue. And so it's a little bit... I think what we have been trying to drive at is, as you remember last time; it was sort of claims in a cohort of like 50,000 to 150,000 as opposed to jumbo claims. And so, the coding is just one aspect of that. But what we were trying to sort of tease out is how much of it is just sort of the statistical fluctuation of a severity spike, and then how much of it is sort of maybe coming from other drivers, potentially like sort of coding and what that might do. Some of these implantable devices can get marked up pretty severely and start tripping you into that range and on an in-patient admits. So, but make no mistake on in-patient it is the severity issue that is far and away the a predominant issue.

Thomas Carroll - Stifel Nicolaus

So, you're not seeing anything out the norm in terms of hospitals really pushing you on reimbursement increases?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Not in any materially different way. I mean as we have talked about sort of the contracting and where we go with contracts, there has been... has ranged sort of from the mid-to-high single digit, and that's sort of still what's pushing around out there. So that does not seem to be the issue.

Thomas Carroll - Stifel Nicolaus

My original question was, if you just could run through your private-fee-for-service in network over the lat numbers again that Dale I think you mentioned in your remarks.

Dale B. Wolf - Chief Executive Officer

Yes, we start... you guys start with sort of where we have the coordinated care networks. This 13 sort of markets those that we are in today, we have already filed five networks build and are approved for a nine more in 2009. So, within those 22 markets, we cover 58% of our private-fee-for-service membership. And then there are an additional 11 states where we have significant private fee membership, and that is about 26% or 28% of the membership and we're going to go build networks in those places. So you add those together, you are in the 80s in terms of their membership coverage, and we'll figure the rest of it out between now and 2011.

Thomas Carroll - Stifel Nicolaus

Okay. Go it. Thanks for that.

Operator

And we'll take our next question of Scott Fidel with Deutsche Bank.

Scott Fidel - Deutsche Bank

Thanks. First question just interested if you guys are seeing any change in turnaround pricing from some of the non-profit blues at this point? And just recently we've been picking up some data points around bigger price increase that some of blues like Highmark and BCBS of Michigan and Premera [ph] and just wondering if you guys are actually seeing some of that and whether we can expect to maybe see some strengthening affirming the pricing for the blues for '09?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Yes, I would say... we've talked before. I mean certainly the Highmark data point has been out there, and so that's certainly a relevant one and, we would agree that that sort of been present in the marketplace in Western Pennsylvania. But I would honestly say make a lot of... have commented on in a more broad based way. I can't sit here today and say I've seen a real evidence of that. Again as I've mentioned before, I think it's a logical conclusion that that will be how it plays out. But candidly, we are still sort of really in the cycle that this sort of... it's about sort of forward-looking into the fourth quarter of renewals and sales in the first quarter of next year, and I can't say that I got data points to support that today.

Scott Fidel - Deutsche Bank

And then just second question around days in claims payable and we appreciate the color you gave on that, and just what do you think is good normalized range for the DTP going forward, just considering your current mix of business?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

So the change related to Pennsylvania Medicare, as I mentioned is sort of sequential change but that sort of falls out. And so that doesn't recur. So I would say if you take the other change kind of all other things being equal, it should sort of pop back up a day or so. I don't know that, I think may be a day higher which is if I think if you look to the last two or three quarters, this is where we stand.

Scott Fidel - Deutsche Bank

Okay and then just a question on the Part D MLR and look s like there's nice improvement that I think around 1700 basis sequentially. Just interested if that was just all the normal seasonality of the product or were there any other factors that are worth spiking out around that sequential improvement?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

The biggest driver that was the sequential improvement in that. I think we continue to feel good about sort of the cost structure behind that. Again you get some petty real time and good clarity on this as it goes. So the biggest driver was the seasonality there.

Scott Fidel - Deutsche Bank

And then to just reconfirm; so the 9% is still your baseline view of cost trends at this point?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Correct.

Scott Fidel - Deutsche Bank

Okay, thank you.

Operator

We'll take our next question from Matthew Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs

Yes, hi good morning. Could you just help us understand what percentage of your business for '09 has already repriced and how that proportion will increase, as we move over the balance of the back half of the year here?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Yes, now let me tell you, so as we thought about this in sort of these different pricing pushes and just let me kind of give you an example. You really start pricing '09 effective with your 2/1 '08 renewals, because one month ripples in.

Matthew Borsch - Goldman Sachs

Right.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

And so obviously that's a fairly small approach. But if you sort of think about that sort of cascading of renewals, when we looked at sort of pricing the last two times, we will probably be able to catch call it two-thirds to 75% of the effective months that sort of ripple into '09 because of the calendar.

Matthew Borsch - Goldman Sachs

By when?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

By what we said the actions that we took earlier this year and the actions that were taking now.

Matthew Borsch - Goldman Sachs

Okay.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

So in another words, I have sort of missed if you will, call it a quarter.

Matthew Borsch - Goldman Sachs

Okay.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

That I can't really effect, that just pertains to '09.

Matthew Borsch - Goldman Sachs

And if I could...

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

But I want to be clear on that in thinking about the goal to at least achieve a flat MLR. We have contemplated what we missed in that thinking?

Matthew Borsch - Goldman Sachs

Okay, got it. And if I could ask the question from a different angle; when you get to let's say the end of this quarter so, say October 1. What percentage of that 50% that renews 1/1 will have their pricing locked into place?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

That's almost all of the large group, and we will be real close on the small group that probably won't be out on small group yet. So given that work out I would say two-thirds of the ones.

Matthew Borsch - Goldman Sachs

Okay, that's.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

If not more. Actually its not more. So this way more weighted for the large group so.

Matthew Borsch - Goldman Sachs

Okay. Great, that's really helpful. And just to understand on the Medicare MCR. So I understand why it was a bit higher than what you had talked about on June 18th. But since your outlook is unchanged, are you rolling through an assumption for... to some degree for a better number in the back half of the year than what you talked us through on June 18th?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

No, I still fill good the range and at this point I don't have any different view on the MLR for the back of the year. As it turns out that the additional expense we booked in June was warranted, we should still land around the high end of our existing guidance range.

Matthew Borsch - Goldman Sachs

Okay. Got it. And one more question here on, when you talked about the higher out-patient utilization, why is that not shown up in somewhat higher physician utilization since obviously or at least I would think that physicians are performing their services?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

That's an excellent question and I have asked the same question myself.

Matthew Borsch - Goldman Sachs

Okay.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

But I just I don't have the answer today, on that. Now some of it Matt though is, as I mentioned in of these protocol sort of higher intensity of services. So sort of more services perform, per episode. So that may trickle somewhat into physician but it's for example it's not per se coming from, there is an additional physician office, there might be two new procedures or something.

Matthew Borsch - Goldman Sachs

Okay, and just one more if I could, on the pricing front. So a few of your competitors have talked to varying degrees fairly intense pricing pressures, and what in some cases seems to be, an acceleration on that front that they have seen coming into this year, and most recently WellPoint talking about rate guarantees and premium holidays and trend guarantees. I am just trying to understand why, you guys aren't... you seemingly not seeing any of that; at least as it relates to change for 2008 relative to recent years. Is there anything you can comment on that?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Well, yes and I sort has commented too. And I would... just our experience is many of those factors to me, we've run into for years and competed against for years. So, they don't prose to me, if you like they are existing at a higher level than they have in the past. I mean I think it's stuff like that when we say the competitive environment is tough that you're sort of always fighting against.

The only other thing I would say is that maybe a more directing answer to your question is, sort of a commentary that unlike a lot of our bigger competitors, we are generally playing at the smaller end of large group and in small group and sort of many of those one-offs on rate guarantees and premium holidays that's large groups stuff. And while we are certainly in large group, we're fighting it out a lot more on smaller end of the market and people don't tend to do the sort of one-offs as much there.

Matthew Borsch - Goldman Sachs

Okay.Thank you very much.

Operator

: We will take our next question from Mr. Doug Simpson, with Merrill Lynch.

Doug Simpson - Merrill Lynch

Good morning. Can you just talk about your pricing power in the market, conversations you are having with customers, given the macro backdrop. And you be specific as to, how much of a price differential can you push relative to trend without seeing an impact on retention? Is it... if trend is running nine now, if you take up price ten, are they okay with that or will that cause them to shop. How close do you have to play that?

Dale B. Wolf - Chief Executive Officer

Maybe it's not a science here. It is a lot of art as well for couple of things, and it's all relative. And some people have already started to ask the question earlier this morning, a lot of it depends on what our competition does. Because at the end of the day, there is some pushback depending on the absolute number from our client. But it's going on depend on what is going on in the marketplace.

And so the competitive response here and what others do is probably the biggest factor in that. We have often said, and this isn't perfect, but we should never lose an account over less than five points priced. It probably takes more than that to move an account if it's just the priced issue. But you should never lose that. And so, if we're within that range already of the market and the pricing push that we are talking about, it's certainly less than five points. I would like to think that our ability to hang onto this stuff and win new stuff is only modestly impacted. But again depending on what the competition does.

Doug Simpson - Merrill Lynch

Okay. And then just given the tougher macro backdrop, are you seeing providers at all trying to target income to a maybe more intensive care patterns?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Yes. But what's new?

Dale B. Wolf - Chief Executive Officer

Yeah, but that's that precisely Doug, some of these things that we are observing in certain help plans would appear to be in those kind of things. I'll over simplify it. But if somebody comes into the ER with symptom A, you are going to do sort of high-cost procedure B, as opposed to maybe lower more effective procedure C. So it does appear like some of that is going on.

Doug Simpson - Merrill Lynch

Okay.

Dale B. Wolf - Chief Executive Officer

But that's not new per se, it may accelerate up and down from time to time, but that's again what I call sort of the cat and mouse game we always play.

Doug Simpson - Merrill Lynch

Okay, I mean I... we're listening to all the calls from all the different companies, and you guys have obviously seen a different trend in medical costs from the Q1 conference calls where we are now. Just putting everything you have seen in the last couple months, any colors to maybe any timing issues or sort of what are the two big reasons why you are maybe seeing a different trend than the others. Is it geography?

Dale B. Wolf - Chief Executive Officer

No. Doug, I am sorry. We aren't going to help you with that, because it's pure speculation of it and you can speculate as well as we can about different sizes, different geographies, different whatever. But obviously, we have no insight into their. So, all we can do is better understand our own.

Doug Simpson - Merrill Lynch

Okay. Have you ever seen a situation just over the last five or six years where it's been that divergent that it hasn't sort of comeback together?

Dale B. Wolf - Chief Executive Officer

Probably not to this extent.

Doug Simpson - Merrill Lynch

Okay. And then just lastly, can you just remind us what's the free cash available for parent and give us a sense for free cash relative to net income. How's should that ratio look going forward?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Let me got the first one. As we have about a $100 million of free cash at the parent as of $630 million in terms of deployable free cash for the back half of the year, was probably around $200 million. But as I mentioned some of that will go or has already gone towards the share repurchase of 3.1 million shares in the third quarter. And your last question tell me again, you want free cash at the parent in proportion to net income?

Doug Simpson - Merrill Lynch

No, just think that operating cash relative to net income what kind of ratio.

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

We have been 120 to 140 up and down in that range over the last few years and I think in our modeling that still looks like a good number.

Doug Simpson - Merrill Lynch

Okay. Alright great. Thank you

Operator

: [Operator Instructions]. We will take our next question from Michael Baker with Raymond James.

Michael Baker - Raymond James & Associates

So I was wondering if you could provide some color around volumes in the workers' comp business. Give us sense of how those responded historically to our economic downturns as well as any lag times in that and then, if you expect to see anything different in this economic downturn?

Dale B. Wolf - Chief Executive Officer

The claims in the workers comps space are clearly down and some who in that space a lot longer than we have had said on a relative basis they are down more this time than they have ever seen before. And so we are feeling in our case management businesses and we are also in our network business where both of those are dependant on claim volumes. Obviously, we have taken all that in account in our guidance here. But it is one of the reasons in fact the principal reason why we cited some of that, when we they were updated in June and we said at a bunch things although now a major one worker's comp was of them and that's exactly the reason.

Doug Simpson - Merrill Lynch

The reason I am asking the question is this historically what I've heard in economic downturns as well there might be a lag you actually tend to see a pick up, in claims and I am just wondering if over the years with some of the changes in the state regulations that might have been changing the dynamic that we are now or is it just a functional lag?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Everybody has got a different theories on what happens in economic downturns both in the health and on the comp side. The answer to your question is I don't know, let's see.

Doug Simpson - Merrill Lynch

Alright, thanks.

Operator

We'll take our next question with Carl McDonald from Oppenheimer.

Carl McDonald - Oppenheimer & Company

Kind of deeming, could you comment if there was anything unique to you given or recently in the states where you got the big employer accounts, does that make it easier to build networks? Is there any potential forward additional reimbursement from the employer claims?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

The first part of that's relatively easy. Yes, the states where we have bigger employer claims are easier for us to build networks, obviously because you have significant concentrations within those employer claims, but also and not coincidently because they are states where we have major presences already. And in both of those cases, we already have coordinated care, Medicare products built. So you... the challenge with the employer market is kind of the out layers, and that has been a challenge with private fee, it's a relatively small amount of the retirees, but it's an important thing to deal with.

And so, that will be the focus of our activity in ushering these clients into a network-based product of some sort. But we feel really good about those big employer clients because of the reasons I mentioned.

Carl McDonald - Oppenheimer & Company

Alright. And second question is there has been a number of a questions around the timing of renewals. I think it will be helpful if you could walk through a time line say for the small group business that renews January 1. When do you figure out calendar wise what the rate increase is going to be, when does that get released to the brokers, when do the clients actually sign the contracts?

Dale B. Wolf - Chief Executive Officer

Carl sort of working backwards and this is a little bit of generalization because there is different state requirements. But typically, you would want to be getting that into a brokers hands 30 to 60 days before the renewal date. And, so, you are probably working those renewals 60 days sort of before that. So a small group cycle could be 120, 150 days sort of prior at the outside. The large group stuff, smaller large group actually sort of follows the similar cycle to that, but as it gets larger, actually the customer often times dictates when they want their renewal.

Carl McDonald - Oppenheimer & Company

Okay, thank you.

Operator

And we'll take our next from Justin Lake with UBS.

Justin Lake - UBS Securities

Thanks. Just a quick follow up on Carl's portion. I did kind of lost track of that timing. You said 30 to 60 days for the 12% and then you said 120 to 150 is that when you start developing your underwriting?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Yes.

Justin Lake - UBS Securities

Yes, Okay, great and then just one question on of the transition from Private Fee-for-Service. Is there any cost we could think about, that might be different in '09 and '08 as far as investment in building those networks?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Its too early that tell you. There will clearly be some additional costs for those 11 states that I mentioned where we don't have networks today and we need to build them, there clearly will be. But the pace of that, the actual cost to do that and over what time period its just a bit early on that and I don't yet know whether that will be a meaningful number in '09 or not.

Justin Lake - UBS Securities

Okay, and just quickly on the commercial side. You mentioned that the renewals that you have out there that's had some this prior trends, I just want to make sure. You had mentioned that the retention... your retention on those groups has been actually in line to better and you are specifically talking to the reports that has seen a higher trend increase?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Now that I was answering that question in response to we have seen sort of already in the quarter today. So it's still too early as I mentioned, we'll be pushing... we are talking about late third quarter and fourth quarter renewals so we don't have any view on persistency good or bad on that GAAP. Those comments... that commentary was sort of relevant to the sort of what's been going on so to now.

Justin Lake - UBS Securities

Thanks guys.

Operator

[Operator Instructions]. And we'll take our next question from Mat Perry with Wachovia.

Matt Perry - Wachovia Securities

Hi. Good morning, just a question on your strategy going forward in Private Fee-for-Service on the individual side. Is that a product you going to actively try to grow and roam in over the next couple of years or do you more focus on the HMO and transitioning or eventually transitioning these Private Fee-for-Service numbers over?

Dale B. Wolf - Chief Executive Officer

I think you should expect us to do both over the next couple of years. We think that I mean obviously we have believed for a long time, that some sort of network base coordinated care product, was going to either evolve or change or whatever and so we had an active strategy of developing coordinated care networks in more and more markets and we are continuing that and will continue that.

But at the same time private fee is certainly attractive and viable for folks over the next couple of years and we think given the markets we are in and the networks we develop, what it's called in 2011 whether it's a network-based private fee or its PPO. A lot of that depends on the regulations and so on. But, we think we are going to be positioned to have an attractive product for almost all of those customers that we'll try to get some more between now and then.

Matt Perry - Wachovia Securities

And can you just remind me. I know you have some single state kind of group Private Fee-for-Service business. But, have you been active in trying to get broader kind of national group Private Fee-for-Service and does your ability to try to win those accounts is that compromised now that the deeming laws out there for everybody to see?

Dale B. Wolf - Chief Executive Officer

We been active in almost the entire Private Fee-for-Service total employer based market pipeline, we have had all kinds of opportunities. It just still happens that the ones tend to be more geographically concentrated than not. And so I guess you know, your point is well taken if you had an employer who truly had major concentrations all over the country that may not suit us as well as some others.

Matt Perry - Wachovia Securities

Okay. And then last question again on Medicare. If you look at data I think Medco put so and subsidy or the payments about the benchmark in the HMO. If there was a new bill under a new President put out that lowered kind of those benchmarks to the Fee-for-Service level. How good a business would Medicare HMO business be going forward?

Dale B. Wolf - Chief Executive Officer

Couple of things will happen, certainly the most dramatic will be the growth will be slowed, because supplemental benefits which are certainly built into the products today will be less and the seniors will see less benefit differential.

Having said that the value of the medical management in a Medicare senior piece of business is significant. And if you think about it sort of compare to like the traditional Fee-for-Service and that's up were just collectively essentially no management, we are still at the terrific value proposition albeit not as attractive as it is today.

So the scenario you are painting whether it's a 100 or 102 or 105 or 108 is one we have anticipated directionally and one of the reasons why ultimately a network-based coordinated care product is likely to be a more prevalent. But the value preposition is still there just not to the extent it is today.

Matt Perry - Wachovia Securities

Thank you very much.

Operator

And we will take our final question from John Rex with JPMorgan.

John Rex - JPMorgan

Thanks. I am just continuing on that vein for a second here. Dale and Shawn, when you look at your most developed Medicare Advantage HMO markets and you just strip down to a comparable Part A, Part B benefit. Where do think you fall? Can you do that for a 90% of the cost of the traditional Part A, Part B and the traditional program now? I mean when you looked at those markets do you think about viability?

Dale B. Wolf - Chief Executive Officer

I don't have the statistic in front of me. No. The one I always, the one I think about which I think always exemplifies the magnitude of this, if you think about hospital days among an unmanaged senior population, you could be talking about days for 1000 that are in the 3000 range of an unmanaged population.

And coordinative care, Medicare populations depending on practice patterns in the market, those days per 1000 run as lowest 900 in California, more like 1300 to 1700 across our markets. So there is a material difference between that result and the managed population. I just have an... I haven't worked the arithmetic now John to figure out how that falls down?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

Could be at least John I think.

John Rex - JPMorgan

Okay. And then just looking kind of growth going forward, so both those six and those are '07, '08 I guess a significant amount of your organic growth came from private-fee-for-service. And as you think about your '09, where would you bias in terms of where you think organic top line growth will come from throughout for the company? Just kind of you look at it now?

Dale B. Wolf - Chief Executive Officer

I think that the proportionally the largest piece of that will still come Medicare. I think the mix of that between our private fee and coordinated care and employer market and all that stuff is sort of the jury is out on that. But I think arguably that will be the biggest piece.

John Rex - JPMorgan

And so when you take that ends, you still expect some adds in Medicare, it sounds like in '09. The way you are talking about an expectation of a flat commercial loss ratio which I guess would indicate that you expect you used to get growth in commercial operating earnings, if that's occurring. But tell me the reason why would operating earnings not grow for Coventry in '09 on absolute basis? What would be the reasons you wouldn't get absolute growth?

Dale B. Wolf - Chief Executive Officer

One of the reasons would certainly be it we're wrong about to medical constraints either in any of the lines, not only commercial but also in the Medicare and other lines as well. One of the reasons would be if we are wrong about of this price push and it has a more detrimental effect on our commercial membership than we are anticipating. And another reason would be if that all the changes in Medicare mean we're wrong about our ability to grow on Medicare membership next year. You think of others?

Shawn M. Guertin - Executive Vice President and Chief Financial Officer

No, I think those were the big ones.

John Rex - JPMorgan

So what's your degree of confidence as you say year-to-date that your operating earnings will be higher in '09 than they were in '08.

Dale B. Wolf - Chief Executive Officer

I will tell you in three months.

John Rex - JPMorgan

So no degree of confidence right now. Is that kind of unusual though that your visibility is either constrained, or do that shaken versus when you think about other years?

Dale B. Wolf - Chief Executive Officer

I don't say... I didn't say I didn't have any degree of conference. I said I didn't have any that I willing to share. And I think that what we been through in the last 30 or 60 days and all other changes going on in the marketplace relative to trend, price push, Medicare, and so make us appropriately conscious about going there in terms of '09 at this point.

John Rex - JPMorgan

And you are buying your own stock, so hopefully you are investing that money wisely.

Dale B. Wolf - Chief Executive Officer

We both hope so.

John Rex - JPMorgan

Yes, okay. Great. Thanks.

Operator

That concludes the question-and-answer session today. At this time, I'd like to turn the call back over for any additional or closing remarks.

Dale B. Wolf - Chief Executive Officer

We're finished. Thanks a lot.

Operator

That concludes today's teleconference. Thank you for your participation and have a great day.

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Source: Coventry Health Care, Inc. Q2 2008 Earnings Call Transcript
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