Universal American Corporation. Q2 2008 Earnings Call Transcript

Universal American Corporation (UHCO)

Q2 2008 Earnings Call

August 1, 2008, 9:30 am ET

Executives

Richard Barasch - Chairman and Chief Executive Officer

Rob Churl - Director of Investor Relation

Robert A. Waegelein - Executive Vice President & Chief Financial Officer

Analysts

Joshua Raskin - Lehman Brothers

Daryn Miller - Goldman Sachs

Jukka Lipponen - KBW

Justin - QVT

Presentation

Operator

Good day everyone and welcome to the Universal American Corporation Second Quarter 2008 Earnings Conference Call. At this time I would like to inform you that this conference is being recorded and that all participants are currently in a listen-only mode. I will now turn the conference over to Mr. Richard Barasch, Chairman and CEO. Please go ahead sir.

Richard Barasch - Chairman and Chief Executive Officer

Thank you and good morning everyone. Welcome to the Universal American Second Quarter 2008 Conference Call. I’m here with Bob Waegelein, our CFO, and Rob [Churl] our Director of Investor Relations.

Before we begin I’d like to ask Rob to read the Safe Harbor Language.

Rob Churl – Director of Investor Relation

I’d like to remind you that some of the information discussed during this conference call will constitute forward-looking statements within the meaning of the Federal securities laws. These forward-looking statements may include statements regarding likelihood or effective any legislative or regulatory changes our expectations of the performance of our Part D Med supp and Medicare Advantage businesses and other lines of business. Estimation of loss ratios and lapsation, adequacy of reserves, our ability to institute future rate increases, expectations regarding our Part D and Medicare Advantage program, including our estimates of membership, costs, revenue and future operating results and the risk inherent in this business.

Identification of acquisition candidates, the completion, integration or accretion of any acquisition transaction such as the MemberHealth transaction and the viability of any acquisition n proposal.

Although we believe that the expectations reflected in these statements are based upon reasonable assumptions and estimates, we cannot give assurance that we will achieve the expected results.

We also suggest that you review the most recent risk factors that we periodically filed with the SEC. Richard.

Richard Barasch - Chairman and Chief Executive Officer

Thanks Rob. This morning I will go and spend sometime talking about the quarter, the quarters you should speak to Bob we will allow with any specific questions about the numbers. I want to focus my remarks and the progress that we’ve made since the beginning of the year, our plans were going forward, especially inline patches of HR 6331.

Several years ago we chose to focus on the senior market largely because of the compelling demographics. This strategic direction has been validated as we’ve grown from $70 million traditional insurance career 40 years ago, it was $4.5 billion company that is emerged as a leader in the Medicare Advantage and Part D businesses.

Medicare is a complex business that has protocol and regulatory as we all as risk management and execution challenges. Nevertheless, we continue to believe strongly in the future of the market broadly defined as providing valuable health insurance coverage to seniors. These specifics will change but the need for these coverage’s will grow and we’ve demonstrated our ability to adapt quickly as the market and the environment changes.

We start with several core strengths that give us confidence in our ability to thrive in light of the changes we know about and that was that we anticipate. First, we have seasoned operating model that has enabled us to become the leading Medicare Advantage play axis, our short service build upon strong and granular partnership with primary care physicians whose mission to provide the best health outcome which not coincidentally also leads to lower cost. We’ve always believe that the future of Medicare Advantage laid in the establishment of networks that are capable of managing Medicare beneficiaries to better outcomes and lower cost. We’ve proven this in Southeast Texas that are now in the process of proving this and our expansion into more locations. To us, the issue is not only whether we can build or acquire a large number of network. In order to build an enterprises and joining value our goal is to work in collaboration with providers to create better and more effective outcomes for our members.

We also believe that the rapid growth of our privacy for service business has accelerated our evolution toward a long term goals. First the rapid growth afforded us the ability with building infrastructure Medicare Advantage that also benefits our network based plans. We have and continue to invest in technology and processes that will allow us to become a low cost provider.

Next, and this is quite important. We’ve learnt sometimes the hard way, the critical risk management skills that are necessary to price the products to appropriately point the results in the Medicare population. Finally, we are nearly a 190,000 privacy for service members, we have chosen our companies to health insurance careers. While we don’t have networks in all the location in which we have members, we anticipated the recent legislation and as a result have already begun a multiyear effort that has so far enabled us to file PPO product in 17 markets.

In 2009 our PPOs will cover around 10% of the current footprint of our privacy per service business, but we have leading plans for network coverage, about the 80% of our privacy per service membership over the next two filing years meeting up to 2011.

To that end, we are concentrating our contracting and marketing efforts toward building a larger presence in each of the market where our members currently reside. As we build membership in each of our core market creating networks will become easier. It is also important that we are now nearly trying to compete with the market with PPO contracts just to be able to move our membership to 2011. We are also working to bring the critical elements that have made our HMO so successful to as many new markets as possible. Part D also plays an important role in our overall strategic plan, in and now itself the Part D business has proven to be quite successful for our company in the first three years even factoring in the initial points in MemberHealth. We now have a two program the third largest Part D business in the country serving more than 1.8 million Medicare beneficiaries across the unique relationship with National Association of Community Pharmacies.

When we look at new markets in which to build our Medicare Advantage Networks a critical factor is how large our Part D membership is in those areas, especially under the new marketing roles. Our ability to discuss additional healthcare options with our members should be a distinct advantage.

We’ve also built a vibrant, experienced distribution capability careered independent that has helped us to get to the position that we currently occupy and will enable us to resume our growth. This too is one of our core strengths. We supported our rapid growth with a solid financial structure that provides a lot of flexibility, all of our major businesses are profitable, we have a comfortable of leverage our subsidiaries are well capitalized and generating cash and we hold a significant rate of unregulated cash at the holding company. In addition, our legacy businesses with the possible exception of the small remaining long-term care block. Our salable assets that can generate additional capital should we decide to go in that direction.

We look to say the past several months have been challenging for Universal American and our share holders. But we have addressed each of the issues and believe that we have made progress in each area concern. Although we have lower private-fee-for service enrollment that we had anticipated at the beginning of the year, our margins of private-fee-for-service for 2008 are expected to be higher than 2007 consistent with our expectation.

As each quarter passes, we are becoming more familiar with behavior of the block and our base for 2009 has reflected what we have learnt. As promised we immediately attack the issues surrounding the MemberHealth transaction and we believe that we are on the path towards solving them. We’ve accelerated the prices rationalizing cost and integrating the operations of our two Part D businesses and have already begun to see meaningful savings in 2008 with more income in 2009.

We have already begun to take the steps required to reduce our benefit cost structure particularly adds to the cost of drug so that we can continue to offer a competitive product and remain profitable. Or we can predict the results of the bidding prices, we are comfortable that we can structure our bids using sound assumptions reflecting many of the improvements that we have made.

Unfortunately, we will continue to take the pain in our sub prime portfolio. With the benefit of high insight as we discussed last quarter it was clearly in the stage to change extra yield but purchasing securities that ultimately have more risk than that we have thought. Having said that, we are guardedly optimistic with the level of write-downs that we are taking it’s somewhere in excess of what we see as reasonable probabilities, actual loss and less economic condition continue to worsen from here. We have however sold on a tax strategy that commits us to tax effect the book losses that we have taken including those taken in first quarter of this year.

There are other less reasonable important issues that have our attention in 2008 managing the growth this company has achieved has not been simple. We continue to make significant investments in our infrastructure with a view toward improving our service and lowering our operating cost especially as we’re unaware our PPO products in 2009. A key '08 element of this effort has been the recent hiring of several experience in qualified people at all levels of the company.

We have also focused on optimizing our capital structure and as several tools at our disposal. First, we completed the first $15 million stock buybacks and our board has authorized an additional 50 million which we will begin to deploy. We have both the balance sheet strength and the liquidity to do this without strength. In addition, we are considering transaction to take transactions to dispose of our non-core assets, if we do so we will get the benefit of additional capital of simultaneously reducing the distractions that are inherent in non-core businesses.

Let me turn now to the highlights of the quarter. We continue to generate excellent results from our Medicare Advantage HMO’s. HMO’s Membership grew 16% year-over-year to approximately 54,600 as of June 30, 2008 and our profitability remained strong. Our expansion efforts have begun to bear fruit as we experience more than 200% membership growth in our new market in Oklahoma, North Texas and Wisconsin. These results give us guidance at the model that has worked so well in Southeast Texas, a real strategic and financial partnership between the providers and us that held the plan is both attractive and achievable with other markets.

We are also very pleased with the results of our private fee-for-service business. Excluding the prior period positive development, our benefit ratio for the second quarter is inline with our guidance and we remain comfortable with our forecast to the balance of 2008.

Our Part D business has also performed well basically inline with our revised expectations with MemberHealth. This give us confidence that we had the right baseline metrics upon our wish to correct to 2008 bid issues when re we submitted the 2009 bids. We are however, signed of cost inflation as required as to be somewhat as to cautionary in our outlook for the balance of the year.

Let me finish my prepared remarks by talking a little bit about the guidance for the balance of the year. All, we are reiterating our full year guidance of between $1.56 and a $1.74 excluding realized losses. The results for the second quarter were better than our expectations vis-à-vis as a result of the positive prior period development in private fee-for-service. In addition, our share count has been reduced by the completion of the first 50 million of our buyback program. However, we will maintain our guidance for the full year to account for further reductions and expected investment income as we’re located into safer, the lower yielding short term investments, indications that increased drug cost in our Part D business and some additional expenses that we planned to incur to get ready for the 2009 selling season including the rollout of our PPOs.

I am sure you will have several question and Bob and I will be happy to answer to them.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Joshua Raskin of Lehman Brothers.

Joshua Raskin

Good morning. First question just on the higher growth cost in the PDP, I was just wondering if you could explain sort of that a little bit more in terms of what exactly is driving them?

Richard Barasch

Well, we are not seeing changes Josh in incidence, but we’re seeing a really more inflation that we had expected in the cost of the brand drugs.

Joshua Raskin

Okay. I am just curious I mean, I think a lot of the IMS surveys – we’re just not seeing that price inflation. So there is something in to the senior population that maybe admist?

Richard Barasch

You know, again Josh, this is relative to our expectations. So..

Joshua Raskin

Got you. That’s helpful. And then the second question..

Richard Barasch

Just to reiterate this, one of the challenges of Part D is in the May of 2008 we have to predict inflation for the balance of 2009.

Joshua Raskin

Yeah, obviously, and unfortunately that happens every year. I guess the second question is on the PPO networks that you guys are – you got 10% of your private fee-for-service covered in 2010, any color on the networking process there, how are those sort of unit cost coming in versus your expectations?

Richard Barasch

We see unit cost of -

Joshua Raskin

Just a PPO you know, what you’re paying at the hospitals and things like that?

Richard Barasch

You know, we’re giving cost so far and thus far, we’ve not seen any indications that we’re going to have significant issues on unit cost. Obviously, part of the network, the contracting program is to make sure that happens. You know my guess though is that at the margins in certain locations where hospitals have significant market presence, we probably will not to deviate.

Joshua Raskin

Where did the PPO and MLR end up long term, is that somewhere between private fee-for-service than HMO?

Richard Barasch

Well, you know, again it’s really a little bit too early to speak, to be many more than predictive or speculative about that, but I actually take it along that closer to private fee-for-service.

Joshua Raskin

Okay. And then last question I guess may be more for Bob. There has been a lot of onetime items in the first half of the year and so, just kind of figure out run rate and as we think about 2009 earnings with all the positives sort of one timers, I guess, its probably too early to know if you’re – in terms of guidance for'09, but do you think earnings per share will be up and maybe if you could just isolate what you consider to be one time items for'08?

Robert Waegelein

Yeah think it’s really too early to see that we the start talking about '09 guidance or indications of the where we go from '08. But again in the first half Josh, as you recall in the first half we put up some additional reserves of what we thought we are still developing some private fee-for-services in the fourth quarter that are not materialize so that that came down. So when we look at really the run rate, the first half in the aggregate is a good run rate for private-fee-for-service you know a little bit improvement that go through the million dollars or so for `07 that came into `08 to the two quarters.

Joshua Raskin

Right. But then I think there is some additional MemberHealth payments and then obviously the tax benefit you saw in the second quarter?

Richard Barasch

Again the tax benefit is really below the line related directly to our sub prime write downs that we occurred. So it’s directly related to that, and I think that sort of analyzes our members extra realized gains and losses and our guidance is geared towards that kind of discussion. The MemberHealth revenue items again a little choppy, but this is a big part of our numbers and MemberHealth dominates the revenue line and little movements of those could skew numbers, and that’s just the rate of revenue comes the past with experiencing how the cord is calculated in live.

Joshua Raskin

Okay, thanks I will get back in queue.

Operator

Your next question comes from the line of Daryn Miller of Goldman Sachs.

Daryn Miller

Hi good morning. Richard, kind of fee like a question for you when you get the benefit design of a PPO product to compare that to private-fee-for-service, you know, assuming the private fee-for-service product it totally goes away, how many of those lines – what percentage of those lines can you actually get to migrate the PPO and what percent falls out and goes back to traditional Medicare?

Richard Barasch

Here again you have to answer a second question to that which is going to be directly reimbursement what our outlook is going to be. So I think I will take that in survey, if you want to get really too likely you sort of add that piece to it. But assuming , lets start with one assumption that reimbursements don’t change dramatically or they change over a period, I think that the population, the demographic population is going to attracted to Medicare Advantage has largely been in the lower half of the economic spectrum, problem was – the problem was going back to traditional Medicare and then perhaps buying Medicare Supp, is the Medicare Supplements has gone very expensive, you know, compounded we had compounded annual rate increases between 8 and 10% over the past five or six years. So there were many of the people in the part of the demographic that are our memberships it is possible for them get a supplemental benefit package at a cost they can afford. So in PPO that’s wide enough that has a good squawking of doctors and put it hopefully in their own, in their locations, it should be pretty attractive. The movement from privacy-per-service to the PPO assuming that the primary care physician is still available, it shouldn’t be that difficult.

Daryn Miller

Right. And I am sorry if I miss when the network provisioning goes in place what percentage of your existing population do you expect to have a PPO alternative for?

Richard Barasch

You know the goal - the goal is 80.

Daryn Miller

80%?

Richard Barasch

Yes. You know basically and this should be a surprise, we’ve got, our membership is fairly concentrated and not coincidentally it’s concentrated in the place where we have good distribution. So we actually have isolated 80 markets in which we have a pretty fair membership penetration. As I indicated also, we have also got a lot of Part D members in the collocation as well. So we’ve got, we’ve got a pretty good size point to be fishing in, and the reason that this is important is its not Universal American kind of running as a company, trying to play a flags in all counties and 50 states, we realized that that’s an effort that’s probably beyond our ability to do. On alarm, there are other alternatives that we would explain them but on alarm, we are concentrating ground up on finally one membership and fundamentally working off the membership that we’ve go to go through this two-thirds of providers that our members are using in order to create these networks.

Daryn Miller

Fine, and what percent of your card membership will be exempt from the new provision?

Richard Barasch

Its around 10% from basically where we can tell, but that now virtually change.

Daryn Miller

Got you. And one last question, the traditional business came in lighter than I was looking for. Was that Medigap driven and was that more from a policy perspective with that write-off or was that maybe the…

Richard Barasch

No, there are actually two components, one is that lighter than net investment income reduction find its way into the traditional business. And two, we have – we see a spike up in many gap claims of, specially the scale nursing facilities, you know, that probably had the most impact in the quarter.

Daryn Miller

Got you. Thank you very much.

Richard Barasch

Just as insight, you know, certain reps around Q2 sort of first question you asked. Med Supp is expensive, because Med Supp is price based on a completely unmanaged Medicare population, and everytime there is change in behavior, change in utilization in the Medicare population, Med Supp price go up. Now, keep in mind we’re stil in the Med Supp business and we are delighted to be in it because to the extent there is some softness on the ages of private fee-for-service and we’re going to made a great position in Med Supp to benefit from that. The Med Supp is largely going to be a product for the wealthier percentage of the population.

Operator

Your next comes from line of Jukka Lipponen of KBW.

Jukka Lipponen

Good morning all, I guess my first question is, can you give us a little more color on this the negative development you took in the first quarter and now kind of reversing that what was it that the cost to be so conservative and now being constable and going ahead in releasing it?

Robert Waegelein

Yeah, it may kind of little bit avoiding the issue, but these are still new parts of business you’ve got. Yeah we closed in 70,000 to of course higher 90,000 in the course of 2007. You know, there is – we had some issues we’re getting on membership correctly or close to the begging of the period. So we were gaining with – we were gaining a very new and only stable population. One of the issues in private fee-for-service is that it probably too providers longer to figure out how to get their claims to us then one would have thought going into the program. We’re pretty conservative in the way we look at this, all through the period and that conservatism may think there were conservatism, because it implies, it implies a conscious decision to be conservative. We were trying to put ourselves in a position where we’re always feeling that we were ahead of the game. So indications during the first quarter then we had been short to our completion factors that we were taking completion factors that were too correct based on the expected behavior, and again we try to be cautionary, it wasn’t pleasant to have to record prior period negative development. But over the past three months as we added results of several (inaudible) if you are tended to monitor the additional reserves we took for 2007 were not necessary.

Jukka Lipponen

Thank that’s helpful. The other question, with respect to what you expect for your sub prime book ultimately, I think a couple of quarters ago you seems to feel pretty comfortable that you would fully recover everything, I think your commentary now is little bit different. So can you give us color on your expectations there?

Richard Barasch

First of all, I gave the impression last quarter with respect to full recovery, I apologize, I never meant to do that, I don’t think that’s what we actually said. But, last time impression I apologize, because that’s not how we felt.

Jukka Lipponen

No, I meant, couple of quarters ago and then last quarter its……..

Richard Barasch

No. I think you know consistent with the way the pricing on this has gone we – last year, two three quarters ago, we saw a lot of the issues were strictly getting the market value and the securities had dropped. Underlying this there was a series of cash flows, and in some of our securities we’ve gotten more convinced than we actually will more likely to non-incur a loss. We still believe that the market prices of these securities are less in the aggregate that our ultimately recovery will be, it’s very too early to speculate as that’s going to, and that’s right.

Jukka Lipponen

And my last question and I am not looking for obviously any names, but in the last two years, have you been approach by one potential acquires to buy the company?

Company Representative

I think, I can’t answer that question.

Jukka Lipponen

Thank you.

Operator

(Operator Instructions). Your next question comes from the line of Justin (Kaine) of QVT Financial.

Justin

Good morning gentlemen. I am curious I just want to know if you could talk me through the tax valuation allowance, was 10.4 million that you took and I would just like to know sort of why you claim that allowance in the first quarter and what's changed in the past two-and-half months that caused you to reverse the allowance now?

Robert Waegelein

Again, this is pretty intricate taxing interpretation of tax law and as we went through the IRC code the write-down came a little quicker than they may gain later in the first quarter and we are going to have the necessary times to prepare an analysis and invest analysis to support our tax position with much between the quarters, we did our research and realized there is tax credit that allows deductions that would offset this. So we took the release this quarter.

Richard Barasch

And again as you – as you back to our March in the first quarter, we typically said that the tax change at that point hadn't been settled and we would hope to get it settled by this quarter. So this is the result of work that was done between since the last conference call.

Justin

Okay. And if you don’t mind can you specifically tell me, I know it might be getting into a little too much of the gory details, but just sort of what elements of the tax treatment were in dispute or…?

Robert Waegelein

Again I think your opening comment is correct, I think it's too much detail for this call.

Jason

Okay.

Operator

(Operator Instructions). There are no further questions. I will now turn the conference back to management.

Richard Barasch

Thanks everyone for joining us this morning. If, as I said, you have any further questions, please call Bob or Rob. Have a nice rest of the day. Thanks very much everyone.

Operator

Thank you again for participating in today's conference call. You may now disconnect.

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