HealthSpring, Inc. Q2 2008 Earnings Call Transcript

Aug. 4.08 | About: Cigna Corp. (CI)

HealthSpring, Inc. (Pending:HS)

Q2 2008 Earnings Call Transcript

July 30, 2008 10:00 am ET

Executives

Herbert Fritch – Chairman, President & CEO

Kevin McNamara – EVP & CFO

Analysts

Josh Raskin – Lehman Brothers

Charles Boorady – Citigroup

Scott Fidel – Deutsche Bank

Justin Lake – UBS

Mat Perry – Wachovia Capital Markets

Carl McDonald – Oppenheimer

Darren Miller – Goldman Sachs

Operator

Good morning and welcome to today’s HealthSpring conference call to review its financial results for the second quarter and six months ended June 30th, 2008. The financial results were issued yesterday after the close of market trading. If you did not receive a copy of the press release, you may find a copy under the ‘Investor Relations’ tab on the HealthSpring website at www.healthspring.com.

Before we begin, HealthSpring wishes to express that some statements made on the call will be forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual performance of the Company may differ from that projected in such statements. Investors should refer to statements regularly filed by the Company with the Securities and Exchange Commission for a discussion of those factors that could affect the Company's operations and the forward-looking statements made in this call.

The information being provided today is as of this date only, and HealthSpring expressly disclaims any obligation to release publicly any updates or revision to these forward-looking statements to reflect any changes in expectations.

In addition, certain non-GAAP financial measures may be covered in this presentation. These non-GAAP measures are reconciled to the most comparable GAAP measures in the press release, or on the Company's website. Just as a reminder, today’s call is being recorded.

At this time, I will turn the conference over to Mr. Herbert Fritch, Chairman, President and Chief Executive Officer of HealthSpring. Please go ahead, sir.

Herbert Fritch

Thank you, operator. Welcome to the HealthSpring’s 2008 second quarter earnings call. We are pleased to report a continuation of strong 2008 results allowing us to increase our EPS again to a range of $2.05 to $2.15 per share. The main drivers of the second quarter results of operations were very favorable retrospective risk adjustment settlements both for the final settlement for 2007 and for the first half of 2008 combined with medical expense trends that were essentially in line with expectations and improving operating leverage and SG&A expenses.

The higher revenue reflects an increase in the risk scores of our membership. We believe this reflects both the health acuity of our members experienced in 2007 and the continuing progress of our efforts to educate our network physicians regarding the appropriate documentation and coding of our members’ diagnoses.

Our actuaries also continue to refine their estimation methods and to improve the basis for our estimates. We believe that our higher level of physician engagement such as through our partnership for quality LivingWell Health Centers and other initiatives has encouraged physicians to be more proactive in the identification and treatment of our members’ clinical condition, which by design should lead to earlier diagnosis of better outcomes for our members. Over 30,000 of our Medicare Advantage members are part of our fee per queue [ph] program and we expect to increase this number to over 40,000 by year-end.

We are also pleased to announce the opening of our third LivingWell Health Center next month in Houston. These centers are real working models of the advanced medical home concept adapted for HealthSpring’s members. We continue to be pleased with the results and are looking to new ways to scale the model moving forward.

Overall, healthcare costs have come in – have been largely in line with expectations. Taking into account the better-than-expected PMPM revenue numbers, we are now revising our MA MLR guidance for the year to at or below 79%. Given the concerns last year that our medical cost trends have not been adequately reflected in the 2008 bids we are pleased that we have succeeded in enhancing gross margins rather than experience degradation. We are optimistic about our 2009 bids allowing for some benefit enhancement while maintaining targeted margins.

One negative from the quarter is the higher-than-accepted MLR of our stand-alone PDP product, primarily attributable to higher cost per script. We are revising our PDP MLR guidance to a range of 85% to 87% for the year. Kevin will speak to the reasons for this later in his remarks.

At these levels, the margins on this line of business are still acceptable. The higher cost per script is also within the ranges and better than our bid submission for 2009 as our actuaries anticipated higher cost trends based on industry trends. Of course, at this point we still do not know where these bids come in relative to regional benchmark.

On the membership front we are seeing our new product Care SNP drive enough sales to allow for net growth in membership during the lock-in months. Recent months have seen net growth in the 400 to 600 member range each month. We have made a slight revision downward in year-end membership for the MA-PDP to 155,000 to 157,000.

We continue to see steady growth in the stand-alone PDP membership in the 3000 to 4000 members per month range. On the whole, we view the recent legislation related to the Medicare Physician Fee Schedule 6 as a positive for HealthSpring. The reduction in revenues related to the phasing out of IME payments in the base rates is limited to 60 basis points per year starting in 2010. Our overall exposure to the reduction in IME payments once fully phased in is small and across all plans should not reduce our MA premium revenue by more than 2%. This is a very manageable amount that should not in and of itself lead to any benefit degradation. The elimination of private-fee-per-service redeeming in most counties for 2011 will probably reduce the number of competitor in many of our markets or at a minimum give us significant network advantage based on the number of exclusive relationships we have in some of our markets.

We continue to believe that our tightly managed network based coordinated care plans will position us to be one of the long-term survivors in the Medicare Advantage program. The ability to demonstrate value both government as the payer and the beneficiary will be critical. It will also be critical to be able to demonstrate enhanced clinical outcomes. We are pleased with our progress on all of these fronts.

Lastly, I would highlight our use of capital to purchase our shares in the open market. In addition, we decided to pre-pay $10 million of our existing long-term debt. We feel our strong balance sheet and cash position combined with a healthy anticipated cash flow allows for us to be opportunistic in our use of capital. We continue to have the financial flexibility to evaluate all uses of capital from investments in our existing operations to geographic expansions to acquisitions to stock repurchases.

With that, I would like to turn the call over to Kevin to discuss the financial highlights for the quarter.

Kevin McNamara

Thanks, Herb. Before I discuss our results in detail, I want to add more color to Herb’s comments regarding the significant level of risk adjustment premiums we recorded during the second quarter. As you are all well aware, we started accruing for all risk adjustment payments both in-year and prior year amounts beginning in 2007. The in-year accruals started during Q1 of 2007, and the prior year accrual began in Q4 of 2007.

Our actuarial and finance groups are constantly updating their models with the most recent claims data to estimate and appropriately accrue for the effects of changes in our risk scores. However, until we are notified of the actual amounts of these payments form CMS typically early in the third quarter of the year our accruals are only estimates.

Our Q2 results include the truing up of our accruals to these actual amounts. This resulted in an additional $17.3 million of premium revenue in Q2 for changes in estimates for the 2007 final settlements. The second quarter of 2008 also includes approximately $6.6 million of premium revenue for in-year risk adjustment that is associated with the first quarter of 2008. As a reminder, for comparison purposes, the 2007 quarter included 415.5 million of premium revenue for 2006 final risk settlements. When I speak later to premiums PMPM, I will break out the effect of these amounts on our 2008 premiums.

Moving to the quarter’s results, we are pleased with our performance, including our reported quarterly net income of $40.2 million, or $0.72 per share, an increase of 71.4% compared to 2007 second quarter EPS of $0.42.

Significant factors impacting the 2008 second quarter were the following. On the positive front, one, the previously mentioned additional premium revenue for retroactive risk adjustments recorded during the quarter. Two, a 125% year-over-year growth in our PDP membership. Three, increases in the PMPM rates for our Medicare Advantage and PDP members. Four, significant improvement in our MA, including MA-PDP MLR on both an as reported and as adjusted basis. And five, leveraging of our SG&A infrastructure with SG&A as a percentage of revenue declining to 9.9% of revenue as compared to 11.4% in the second quarter of 2007.

On the negative side - 545 basis point year-over-year erosion in the MLR of our PDP business. Two, expected declines in the profit contributed by our commercial business. And three, additional amortization expense of $3.3 million and incremental interest expense of $4.5 million related to the acquisition of LMC Health Plans.

We reported 153,958 Medicare Advantage members at the end of the second quarter, reflecting year to year growth of 23%. 27,017 or 17% of these MA members are from the inclusion of LMC Health Plans in our results. Our 50 basis points growth year-to-date is not unexpected due to previously discussed county exits in Alabama and product changes in Tennessee.

With where we are year-to-date, we have decided to reduce our year ending MA membership guidance to 155,000 to 157,000, reflecting net membership additions of approximately 400 to 600 members per month between the quarter-end and year-end.

PDP membership of 265,425 is up 91% year-to-date. We have updated our guidance to assume year ending PDP membership of approximately 275,000.

Total revenue in the second quarter was $566.8 million, an increase of $183.1 million, or 48% versus the prior year’s second quarter. Medicare Advantage revenue was up 45% or $150.7 million to $482.9 million compared to $332.1 million in the prior year. Primary drivers of this increase were the aforementioned 2007 final settlement risk adjustment premium accrued during the 2008 second quarter, the inclusion of the Florida operations in our 2008 results, and an increase in MA premiums, PMPMs.

For the six months ended June 30, 2008, as reported MA premiums PMPM were 1027.67, an increase of 19.4% year-over-year. Removing the 2007 risk adjustment premiums from our 2008 year-to-date results would yield an MA premium PMPM of 995.63, an increase of 13.5% versus full year 2007 MA premium PMPM as adjusted to reflect premiums associated with the 2007 plan year. This compares to our initial guidance of 10% to 11% rate increase year-over-year.

The year-to-date 2008 adjusted MA premium PMPM of 995.63 should erode slightly over the second half of 2008, but we believe it is close to our run rate.

PDP premiums were $70.8 million in the second quarter of 2008, an increase of $43.3 million, or 158% versus the second quarter of 2007. This increase was driven by the 125% increase in PDP membership and PDP PMPMs, which increased 13% year-over-year. Year-to-date PDP premiums PMPM are 96.51, an increase 7.5% over 2007. Please remember that quarter-to-date and year-to-date percentage changes in PDP PMPMs are significantly affected by risk score adjustments.

Fee revenue for the quarter increased $2.7 million as compared to the second quarter of last year. The increase is primarily the result of higher premiums PMPM and management fees associated with IPAs that have come on line since last year.

Investment income was down 44%, or $2.6 million in the quarter due to the significant decrease in investment yields. Most of our cash investments are held in floating rate instruments, so this decline is not unexpected.

Total medical expense in the quarter was $436.2 million, an increase of $140.4 million, or 47.5% versus the prior year’s quarter. With respect to the components in the relative metrics, MA medical expense was $366.1 million, an increase of $105.7 million, or 41% versus the comparable prior year quarter. Included in the second quarter MA medical expense was $4.5 million in provider risk sharing associated with the 2007 risk adjustment premiums recorded during the second quarter of 2008.

MA medical expenses PMPMs were up 14% over 2007. This 14% increase year-over-year is comprised of 1.4% from the impact of the 2007 risk sharing expense in the 2008 second quarter, 6.3% from the inclusion of LMC Health Plans, and a 6.5% PMPM increase in medical expenses PMPM in the rest of our health plans.

The MA MLR on a reported basis was 75.8% for the current quarter versus the prior year’s 78.4%. Adjusting for the 2007 risk adjustment accrual in the 2008 second quarter the MA MLR was 77.7%. The improvement year-to-year was primarily attributable to increases in premiums PMPM in excess of medical trends. For the six months ended June 30, 2008, the MA MLR was 77.6% as compared to 79.7% in 2007.

PDP MLR in the 2008 second quarter increased to 96.3% versus a year ago 90.8%. Year-to-date, the PDP MLR was 96.6% versus 92.6% in 2007. As Herb mentioned, this year we are experiencing higher script cost per script than we had originally anticipate. Although we experienced these same trends during the first quarter we believe then there was a temporary phenomenon. However, in the second quarter this trend continued. Most of this increased cost appears to be coming from our new membership in California and New York, the two regions where we picked up the bulk of our auto-assigned membership this year.

Based upon our experience year-to-date we have decided to update our PDP MLR assumptions in consideration of this increased drug trend. We are not forecasting our 2008 full year PDP MLR to be in the range of 85% to 87%. This 200 basis point increase in our PDP MLR guidance is predicated on no abatement in these cost trends during the balance of 2008.

SG&A expenses for the quarter were $56 million, an increase of $12.3 million, or 28.3% versus the prior year. SG&A expense as a percentage of revenue came in at less than 10% of total revenue in the 2008 second quarter compared to 11.4% in both the second quarter of 2007 and the first quarter of 2008. Year-to-date SG&A as a percentage of revenue stands at 10.6%. On a sequential basis SG&A expense declined $6.9 million, or 11%. We continue to expect SG&A to remain seasonally weighted to the first and fourth quarters as a result of the marketing and commission cost associated with the limited open enrollment period.

Moving to items below the EBITDA line, depreciation and amortization expense in the 2008 second quarter increased $4.1 million versus the 2007 [ph] second quarter primarily as a result of amortization expense associated with the LMC Health Plans acquisition.

Interest expense in the 2008 second quarter increased $4.5 million over the 2008 second quarter as a result of the interest incurred on the Company’s $300 million term credit facility entered into in the first quarter of 2007.

During the quarter we made an early pre-payment of $10 million on this loan as well as repurchased an additional 435,000 shares of stock for $7.7 million. This brings our year-to-date repurchase activity to $1.6 million shares for $28.4 million at an average cost of $17.67 per share. We continue to evaluate the most appropriate use of our capital in light of the current interest rate and acquisition environment.

Moving to the balance sheet and cash flow, our balance sheet at June 30, 2008 reflected cash and equivalents of $304.7 million. Unregulated cash was $35.6 million. We had $278.9 million of borrowings under our new credit facility at quarter end. Accounts receivable are up significantly as a result of accruing the risk payments. Days claims payable were 40 days at the end of the quarter compared with 37 at the end of the first quarter and 39 at the end of the second – 2007 second quarter.

Operating cash flow for the six months was a use of $7.3 million versus a source of $21.3 million in the prior year after adjusting for the early receipt of the July CMS payment in June 2007. Operating cash flow during the first half of 2008 trailed net income due primarily to the accrual of – to the significant current year and 2007 risk-adjustment payments. As a result of the increased magnitude in accruals for risk adjustment payments and the timing of receipts of such payments from CMS, cash flow from operations significantly lagged net income for the first half of the year.

During the third quarter of 2008 we expect to receive payment from CMS on these risk payments and our cash flow from operations should reflect a positive $129.3 million variance due to these payments.

As to guidance, based upon the favorable results during the first half of 2008, we are updating our prior operating and financial guidance. Our new 2008 diluted EPS guidance is $2.05 to $2.15. The major components of this updated guidance are one, year-ending MA membership of 155,000 to 157,000; two, PDP membership of approximately 275,000 at year-end; three, total revenues of $2 billion to $2.2 billion; four, an MA MLR at or below 79% for the year on an as reported basis; five, a PDP MLR of 85% to 87% for the year; six, a tax rate of 36.3% [ph] for the year; and an average fully diluted share count of 56.2 million shares, which assumes no additional share repurchases.

Operator, that concludes our prepared remarks. We can now open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And our first question will come from Josh Raskin with Lehman Brothers.

Josh Raskin – Lehman Brothers

Hi, thanks, good morning. Just want to drill down a little bit on the PDP cost that this higher cost per script. So I am curious what’s driving that? Did you have better – assumptions for higher generic utilization or are they using different categories of drugs, I am just sort of curious where that’s coming from.

Herbert Fritch

Josh, I think we are still drilling down to get the details by area and the mix. I think it is a brand and generic mix along with some just straight inflation.

Josh Raskin – Lehman Brothers

Okay. And you have a better – when do you think you will get a better sense of sort of the drivers for that? I mean because obviously the bids are past for ’09 so I am just sort of curious how you are thinking about the benefit design et cetera.

Herbert Fritch

Well, we – I mean we hope to on the next one to two months have some of the details behind this, but what we did on the bids was we had exceptionally favorable trends going into this year, and lower increases than we projected, but on the bids we I guess listened to what our PBM and industry consultants were saying and used higher trends than we had actually experienced and now it’s looking like that was a pretty good move.

Kevin McNamara

We were seeing different patterns, Josh, out of New York and California in the first quarter. We didn’t know how to read them. They persisted in the second quarter. And so as we continue to get more data out of those two markets, which is a big source of our additions, we’ll get a better handle on it.

Josh Raskin – Lehman Brothers

Okay. That’s helpful. And then just a question on the doc fees [ph]. Obviously you talked about the private fee-per-service. Have you done an analysis of how many private fee-per-service members there are in your specific counties that you think will be affected by (inaudible)?

Herbert Fritch

You know, we haven’t done a detailed analysis of it. We have looked at some specific markets. There aren’t – in our big metropolitan markets, the private fee-for service plans are not a major factor. Most of them average less than 1000 members. But that said there are a lot of them.

Josh Raskin – Lehman Brothers

Yes.

Herbert Fritch

So, I don’t know. I would guess that it might be 5% to 10% of the membership in a lot of our markets are private fee-per-service, but not much more than that.

Josh Raskin – Lehman Brothers

Okay, got you. And then just third – last question I guess for Kevin, the guidance on the revenue side, the low end, the $2 billion on the top line would imply pretty significant decline in the second half. You mentioned a little bit obviously the elimination of the risk adjusters, but I am just curious as you guys are thinking about the guidance is it now maybe on the top line closer to the high end or do you really think that there is a possibility as likely on the low end as there is on the high end?

Kevin McNamara

We are probably closer on the high end. The one thing you have to factor in, Josh, is I’ve said in my comments the PMPMs in the second half do continue to run down.

Josh Raskin – Lehman Brothers

Yeah, okay.

Kevin McNamara

As they (inaudible) off, but we are probably close to at the high end than the low end.

Kevin McNamara

Okay, perfect. Thanks.

Operator

And our next question will come from Citi. We’ll hear from Charles Boorady.

Charles Boorady – Citigroup

Thanks, good morning. First, I am just wondering with respect to Leon how did the risk sharing arrangement impact you in the quarter specifically what would the med loss ration have been without the risk sharing agreement.

Kevin McNamara

Well, let me take that, Charles. First, with respect to the med loss ratio on Leon I mean we don’t break out the MLRs on our specific health plans, but there is a new launch [ph] to that acquisition agreement that I will point you to. In terms of the 2007 risk payment, our acquisition was effective 10/01, so all of the risk payments associated with the period through 09/30 go to the sellers. So that would be a purchase adjustment with respect to that acquisition. And then the risk adjustment payments for the fourth quarter of ’07 dial into the calculation of the target just like anything else.

Herbert Fritch

And I mean essentially it’s a 50:50 risk share within a band, and they are within the band for all accounts.

Kevin McNamara

So, to the extent that it moves the MLR it gets factored in.

Charles Boorady – Citigroup

Okay. Got it. And in terms of the performance of your various products, one of your big competitors had an issue with chronic special need plans. I know your special need plans are mostly duals Can you characterize generally speaking how the performance of the dual SNPs compared with any non-dual SNPs that you had?

Herbert Fritch

They are pretty comparable. We’ve had them long enough. We’ve had that SNP product since 2005. We think the business is mature and we price it and go through a bid process with the same MLR targets on that as the rest of our business, and obviously actual varies from projected a little bit, but they are pretty much in line and on target.

Charles Boorady – Citigroup

Are there certain subsets of this population, is that more challenging to manage the costs for more than others?

Herbert Fritch

Well I think in the – on the duals SNPs in the under 65 population you have a lot of severely mentally disabled that’s a challenge. And just generally it’s challenging on the duals because they are just hard to reach and access and a lot of them don’t have phone contacts, that kind of thing, and a lot of the typical health plan management techniques are challenging because of that.

Charles Boorady – Citigroup

So, you would say that the duals are more challenging to manage than the chronics on average?

Herbert Fritch

I’d say that’s true but generally I have to think that that is true. I mean we have some chronics with this new program, but frankly it’s new enough. We don’t have – haven’t had the membership long enough to really draw any conclusions as to how it’s doing.

Charles Boorady – Citigroup

And then just in terms of reserves, I know you didn’t provide a reserve roll forward table and generally don’t in the release. Are you going to provide in the 10-Q? And can you tell us what’s roughly the level of prior period reserve developments were in the quarter that related to prior years?

Kevin McNamara

Yeah, Charles, we don’t provide the roll forwards quarterly. We do obviously annually in the 10-K. But I will comment that the effect of prior period development is relatively consistent year to year.

Charles Boorady – Citigroup

Okay. And then finally, you talked about – if I heard you right, the fact that you believe you just got the opportunity to actually enhance the MA benefit in 2009 while still hitting your target margin. I just want to confirm that that’s correct and that your target margin is still a 80% med loss ratio? And if that’s alright, can you tell us sort of what rate of growth in medical trends you are assuming for 2009 to feel confident that you can actually enhance the benefit for ’09?

Herbert Fritch

I think that is accurate. I mean depending on – it varied a little by market, but we either enhanced benefits or in a couple of markets held them constant. We are targeting about 80% for a loss ratio, which is pretty consistent and we’ve built in about an 8% medical trend per year.

Charles Boorady – Citigroup

Got it. Is – and what rate of premium yield are you assuming you are going to wind up with including risk adjusters and other special payments in 2009?

Kevin McNamara

We are still working through that, Charles. We (inaudible) you give us a little bit of time before we start talking about ’09 rates.

Charles Boorady – Citigroup

I guess what I am trying to understand is that if the cost runs are going to rise to eight, we haven’t been seeing anywhere near that level of premium yields run up industry wide basis for Medicare Advantage and so I guess I am just surprised that you can actually enhance the benefit with an 8% cost trend and just what I am inferring is that you are – you expect to get a more than 8% premium yield all in or am I missing something?

Herbert Fritch

It’s a combination of -- our actual MLRs are below 80. So we—

Kevin McNamara

Degradation implied--

Herbert Fritch

We have a little bit of room on that side and we are confident that we can continue to see some increases in risk horizon probably not the kind of premium increase as we got this year, but the base rates are maybe going up 1% less than they did this year. And we have significantly above 8% in our overall premium yields this year and I think we can get the benefit of some of that going into next year too.

Charles Boorady – Citigroup

Got it. Is there a target EPS growth that is implicit in your assumptions that we should think about or at least a minimum level of EPS growth that you are targeting?

Herbert Fritch

Well we haven’t really done our work on ’09 (inaudible) that gets too soon to comment on that.

Charles Boorady – Citigroup

Alright. Thank you.

Operator

And our next question will come from Scott Fidel from Deutsche Bank.

Scott Fidel – Deutsche Bank

Thank you. First question just around the risk adjusters, and maybe if you could help us think about how maybe that’s breaking up between the higher acuity or I guess worse health status of the members that you are seeing relative to the efforts that you are enacting with providers to improve the code. And maybe if you sort of the mix of how this break out between the two?

Herbert Fritch

You know I don’t know if there is any scientific way to break that out. I know we are jus getting higher acuity risk scores on our patients. We do think there is an overall trend of two to three points in our hospital admission rate that’s consistent with that higher acuity. But that said, I couldn’t tell you how much of the risk score increases that versus better capture and documentation.

Kevin McNamara

And only the other thing, Scott, you could point to, but you couldn’t quantify is year-to-year mix of bills has gone up. So that would suggest it, but you couldn’t quantify.

Scott Fidel – Deutsche Bank

Okay. Then just a question on SG&A, I know earlier in the year you had been targeting less than 11.5% obviously you are doing much better than that so far in the first half of the year. Do you have an updated guidance expectation for SG&A ratio?

Kevin McNamara

Could you just repeat the question, Scott?

Scott Fidel – Deutsche Bank

Just updated guidance for SG&A. I know earlier this year you were at less than 11.5%, but you are clearly doing much better than that so far.

Kevin McNamara

We’ve still got an 11.5% internal target that we operate against. Our current guidance does predicate some SG&A investment in the back half.

Scott Fidel – Deutsche Bank

Okay. And then just on the receivables it sounds like you are expecting that to come down pretty significantly in the third quarter. I think that was tracking up around $78 million sequentially to $175 -- $174 million. Do you have an expectation that maybe by the end of the year what you think the receivables balance will look like?

Kevin McNamara

We’ve received the payment report for July and August, Scott, and we will receive payment that will take that balance down by $129 million. And then the pattern that we’ve gotten into now is that balance will build over the second half and will continue to build all the way until the second quarter of ’09 and then you’ll receive that risk payment, which will bring it down.

Scott Fidel – Deutsche Bank

Okay. Thank you. Those are questions I have.

Operator

(Operator instructions) Our next question will come from Justin Lake with UBS.

Justin Lake – UBS

Thanks. Good morning.

Herbert Fritch

Good morning, Justin.

Justin Lake – UBS

Just a couple of questions around the risk adjustment, first, could you just remind me your accounting treatment for that? Do you accrue for risk adjusters or risk – higher risk scores as you are going through the year?

Kevin McNamara

Yes, in ’08. In ’07, Justin, what we did in the beginning with January of ’07 we accrued for one piece of it for the year, in the year piece. So the accrual had the effect only in the first half of the year. We continue to look at during ’07 did we have the ability to accrue for the final payment and made that determination in the fourth quarter of ’07 where we put up in the fourth quarter of ’07 an accrual for final ’07 payment. We continually look at those accruals and starting in 01/01/08 we began accruing for both. In the first quarter we made an update to those accruals and the relative mix of the final ’07 and the ’08 for the year, in the year. And then in the middle of the year, when you get these payment reports you true up to what the actuals are.

Justin Lake – UBS

Okay. That’s – so, I guess what I am getting at is that the – (inaudible) you received in the second quarter from a risk scores standpoint was above and beyond what you expected to accrue, is that correct?

Kevin McNamara

That’s correct. Both for the year, in the year, as well as the ’07 final, that’s correct.

Justin Lake – UBS

So, can you go through – so there is – so there has been some accrual and then this the above and beyond. So can you give us the full numbers as far as (inaudible) as you get for both the (inaudible) in the year and the – the in the year number and the prior year risk adjusted?

Kevin McNamara

Justin, we anticipate filing the 10-Q quickly on the heels of this call, and you should be able to put that all together in the 10-Q disclosures.

Justin Lake – UBS

Okay. That’s helpful. So, the – I guess if I – can you give us some idea of – if risk scores are coming in what it looks like meaningfully better than even you thought or accrued for, what are you – what is happening? Are you getting a sicker patient, are you doing better on the scoring? Why is it coming in so much better than eve you guys thought it was going to be?

Kevin McNamara

Well – you know we mentioned, I think it’s a combination. I think in ’07 we saw higher hospital admission rates indicating I think sicker patients and essentially the ’08 revenues are based on ’07 dates of service in terms of diagnosis codes. I also think we continue to – we continue to work with our physicians on educating them on the kind of documentation they need and kind of help them in terms of what historical chronic disease codes they’ve turned in and make sure they check the patients during their visits for those. I think some of that you get better and better over time when we have very broad physician networks and you don’t impact a lot of them at all. But gradually they start to get it. The other thing that I think we are benefiting a little from is the fact that we have got so much fewer new patients and new members. We have seen reduced dis-enrollment rates and better retention and the longer you can keep these members the better off you are from a – getting their codes and revenues in line with their health status.

Justin Lake – UBS

Got it. That’s helpful. Is there – from a Leon perspective given how strong you are in this aspect, is that anything that you feel like you can add there as far as improving their risk scores?

Kevin McNamara

It is an area where we think there is some potential. They brought in some outside resources to help them – I don’t know year, year and a half, two years ago, and relative to other providers in South Florida, their risk scores are still relatively low. And there probably is still some potential down there.

Justin Lake – UBS

Okay, great. One last question, just as you think ahead to 2009 and we have a new administration and then probably a new head of CMS I guess just two things, one, when you look back on the February, the February preliminary update for rates and you – and what CMS was thinking about doing from a risk score standpoint as far as looking at coding, how would you – when you look back on that, do you know how you would have shaken out there how many of your members or how much that would have cost you from revenue standpoint? And then looking ahead, is this something that you think CMS – a new CMS administrator would look at for 2009 or do you think it might take some time to – for them to get their hands around it?

Herbert Fritch

I think it’s a very difficult issue for them. If you read into what they published in February the big issue is if they follow that to the letter of the law there all of a sudden would be holding us accountable for the poor documentation practices in fee-for-service medicine. I’ve heard coding experts, and I believe they are probably right, make the comment that 30% of the claims in fee-for-service Medicare, the diagnosis code is not supported by the chart just for technical reasons, not that the member doesn’t have the diagnosis. And if you read what they were proposing, all of a sudden they are holding you accountable to change the fixed doctor coding practices that are very poor in fee-for-service medicine. And so I think they are going to have to significantly look at and refine that approach or the results will be pretty dramatic across the board and the industry.

Justin Lake – UBS

Got it. And do you a number that you would have thought you might have been impacted by?

Herbert Fritch

I think the 30% number – actually a lot of what we are doing – we think we are getting better documentation and then would probably beat that a bit the further forward we go with this, but I don’t have any reason to believe it’s a lot different than the 30% number that these coding experts claim because we are just for the most part accepting the codes from claim submissions from doctors, which is exactly what they do in fee-for-service Medicare.

Kevin McNamara

To the other part of your question, Justin, on what was talked about earlier in the year where they were bantering about this provision if you are in the top 25 percentile we don’t know how we would shake out there.

Justin Lake – UBS

Great. Appreciate the little help. Thanks.

Operator

Anything further, sir?

Justin Lake – UBS

No.

Operator

Thank you. Our next question will come from Wachovia Capital. We will hear from Mat Perry.

Mat Perry – Wachovia Capital Markets

Hi, good morning. Just want to you know maybe some bigger picture questions. You know you mentioned the better-than-expected medical loss ratio was really due to the top line and not necessarily medical management. But can you talk about how you think your medical management on whatever kind of important metrics you track, bed days per thousand or other metrics compares to fee-for-service Medicare?

Herbert Fritch

We think it’s significantly better than fee-for-service Medicare. I mean I kind of believe that you’ve got to do at least 20% to 30% better to really compete in this business. If you look at it, all the fee-for-service Medicare cost contain minimal SG&A. So you’ve got to offset your SG&A, you’ve got to be able to make a profit margin and you also have to be able to significantly enhance benefits for members. So, if you don’t have I don’t know 25% to 30% kind of number in your efficiencies you just can't afford to do all that.

Mat Perry – Wachovia Capital Markets

And I mean am I right interpreting that comment to mean that you could deliver the equivalent benefit that Medicare – that fee-for-service Medicare provides for 20% to 30% less? It sounds like that’s what you are saying.

Herbert Fritch

Yeah, although you know some of that SG&A is medical management SG&A. So I mean if you just looked at our medical cost, but there is certainly some investment to get there, but I’d say 20% might be a good number.

Mat Perry – Wachovia Capital Markets

And what would the landscape or environment look like for HealthSpring if under a new administration they dial back the benchmarks to the fee-for-service level?

Herbert Fritch

We think it looks a lot like the pre-MMA environment where clearly we’d have to reduce benefits, but we think that being in an environment where a lot of other plans are dropping out of the business completely and it’s a lot less competitive. Pre-MMA, we were employing a lot of these techniques. We obviously refined them and I think gotten better over the years, but in that environment we were still running 80% loss ratios while most people were dropping out of the business. And we were able to compete with lesser benefits and still do pretty well simply because most of our competition we met (inaudible) plans, they weren’t other MA plans.

Kevin McNamara

And that’s when we got the highest growth on the member front—

Mat Perry – Wachovia Capital Markets

Right. And that was kind of my other question is does that environment actually make it easier for you to grow? I mean is that almost a preferable environment or do you give back too much in terms of margin to make it preferable to the way things are now?

Herbert Fritch

I mean we believe it’s more preferable for us. Now the degree of that growth really depends on exactly how deep the cuts are and how fast they come, but we clearly grew faster in that environment than we did post MMA.

Mat Perry – Wachovia Capital Markets

Okay, great, that’s all I have. Thank you.

Operator

And our next question will come from Carl McDonald from Oppenheimer.

Carl McDonald – Oppenheimer

Great, thank you. I was interested in your comments around what you think broker compensation will look in 2009. I realize that the final regulations are not yet, but just what your understanding is at the moment?

Herbert Fritch

You know the word is you have to create a flat payment across all years. We haven’t seen the final regulation. That’s a significantly different system than exists today and I think we’ll just be speculating on what exactly that’s going to look like. Today, there is a much higher first year commission and much smaller second or renewal commissions, and I don’t know, I presume you can look at it the first approach would be to make sure commissions in average of across all your membership, and come up with a flat amount. To some extent it ends up being market driven. I mean it’s sort of what are the other plans offering and we haven’t really seen any of the offers yet. I don’t if anybody has kind of even made an initial attempt at what those things are going to look like.

Carl McDonald – Oppenheimer

And is your (inaudible) if it is a flat commission that there will have to be a flat commission across all geographies see that they pay the same commission as the (inaudible)?

Herbert Fritch

You know I don’t know if we’ve gotten into the level of detail on that one. I wouldn’t think so, but that’s a pure guess. I mean we’ll see what the regulations say. It’s clear they are going to regulate commission more than they ever have, and we just haven’t seen what the final rules are going to look like.

Carl McDonald – Oppenheimer

And then just second question on the M&A environment in Medicare (inaudible) valuations for probably (inaudible) share companies have done this year just the overall economic environment, your sense of willingness to sell and where these valuations have moved significantly over the last six months?

Herbert Fritch

It depends. The latter half of that depends if you are a buyer or a seller. I think from the buyer’s perspective, at least from our perspective, we are looking at managed care multiples and have a difficult time paying a much higher multiple than we are valued at, certainly.

Kevin McNamara

Sellers’ expectations have tended to be what our multiples were 6 to 12 month ago.

Herbert Fritch

Yeah, I mean the sellers look back at comps over the last two years and pick the highest number, and that’s a big gap right now. I think that’s – I think generally speaking, there are a lot of potential sellers out there but between the credit markets and this gap in expectations on valuations we haven’t seen too many deals getting done. But I do think there are a number of smaller plans out there that are looking to – to figured out they aren’t going to be long-term players and are looking to sell. But there is obviously a couple of obstacles to get the deals done.

Carl McDonald – Oppenheimer

Okay. Thank you.

Operator

And our next question will come from Goldman Sachs. We will hear from Darren Miller.

Darren Miller – Goldman Sachs

Good morning.

Herbert Fritch

Good morning.

Darren Miller – Goldman Sachs

Herb, question for you. You indicated that the PDP margins are still acceptable at the higher MLR level. You know I am not really sure how SG&A allocates that product, so can you give some color in terms of what the operating cost ratio is on PDP and at the 85% to 87% MLR what the margin is?

Kevin McNamara

Darren, we have (inaudible) not sort of allocate or speak to allocation of SG&A across those two different products. The one thing I will point out and then I think you can do math that will get you in the ballpark is we have no selling cost at all on that product. We are doing exclusively auto-assigned bills on that strategy. So, our SG&A cost include absolutely no selling expenses.

Darren Miller – Goldman Sachs

Any medical management cost in SG&A that really relate more to MA?

Herbert Fritch

You know there is a little bit of prior op stuff we do with the pharmacists and that kind of thing, but it’s not the same degree as we do on the MA product.

Kevin McNamara

There would be a fair amount of medical management cost included in our SG&A expenses, which predominantly related to the MA side.

Darren Miller – Goldman Sachs

Okay. And, Kevin, the $129.3 million that you expect to receive for risk – risk settlement, breaking that out into the final 2007 piece and the 2008 in the year, for the year, is it about $29.3 million for final 2007?

Kevin McNamara

To my earlier comment, Darren, if you just give us a day or two, the 10-Q should get you there on reconciling that.

Darren Miller – Goldman Sachs

Fair enough. Thank you guys.

Operator

And at this time there appears to be no further questions in the queue. (Operator instructions) And at this time there appears to be no further questions in the queue.

Herbert Fritch

Okay. Thank you. We’ll look forward to our next quarter’s call. Appreciate your interest.

Operator

That does conclude our teleconference for today. We’d like to thank everyone for your participation, and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!