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WellCare Health Plans, Inc. (NYSE:OMI)

Q3 2012 Earnings Call

October 31, 2012 8:30 am ET

Executives

Gregg Haddad - Vice President, Investor Relations

Alec Cunningham - Chief Executive Officer

Tom Tran - Senior Vice President and Chief Financial Officer

Analysts

Tom Carroll - Stifel Nicolaus

Scott Green - Bank of America Merrill Lynch

Melissa McGinnis - Morgan Stanley

Carl McDonald - Citigroup

Matthew Borsch - Goldman Sachs

Josh Raskin - Barclays Capital

Michael Baker - Raymond James

Brian Wright - Monness Crespi

Sarah James - Wedbush

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the WellCare Health Plans Third Quarter 2012 Financial Results. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded Wednesday, October 31, 2012.

I would now like to turn the conference over to Mr. Gregg Haddad, Vice President of Investor Relations. You may begin, sir.

Gregg Haddad

Good morning and thank you for joining us. Today, we will be making forward-looking statements, including but not limited to, our 2012 financial guidance. Various risks and uncertainties such as those described in our filings with the SEC, including our 2010 Annual Report on Form 10-K and 2012 quarterly reports on Form 10-Q, may materially impact those statements. While these risks and uncertainties may cause our future results to differ from today's statements, we are not undertaking any obligation to update or revise any forward-looking statements.

Certain financial information that we will discuss this morning, includes adjustments to expenses related to previously disclosed government investigations and related litigation that we believe are not indicative of long-term business operations. We will identify results that have been adjusted. In addition, please refer to our news release published this morning for supplemental schedules that reconcile results determined under generally accepted accounting principles, or GAAP, to adjusted results.

Our news release is published on our website at www.wellcare.com. In addition, today, we will be discussing medical benefits ratios or MBRs for the Kentucky Medicaid program that are modified to reflect the development of medical benefits payable in the period in which the services were provided. A reconciliation of these non-GAAP and GAAP measures was published in our news release.

Following our prepared remarks, we will address your questions, and we request each participant to ask no more than two questions. Our discussion today is led by Alec Cunningham, WellCare's Chief Executive Officer and Tom Tran, Chief Financial Officer.

I will now turn the discussion over to Alec.

Alec Cunningham

Thank you, Gregg, and good morning, everyone. Today I will update you on our recent activities and our priorities and plans for the remainder of the year. Following that, Tom will discuss the quarter's financial results and detail our updated 2012 financial guidance.

Our third quarter results fell short of our expectations, principally due to an unanticipated issue in Georgia Medicaid and performance that was below our target for the Kentucky Medicaid program.

Georgia results were negatively impacted by a partial disallowance by CMS of the revenue reconciliation settlement that we and the other Medicaid plans negotiated with the state in 2011. The settlement resolved issues with certain premium payments that covered from the inception of the program through the settlement and resulted from a comprehensive review and negotiation involving the three health plans that operate in the program. Our discussions with the state regarding its appeal rights relating this matter are ongoing.

In Kentucky, operating results for the third quarter did not achieve our target due in large part to claims activity dating back to the fourth quarter of 2011 and the first quarter 2012. As you recall, during much of that time, our members were in the contractual transition of care period, and consequently we were not able to manage utilization or other elements of the program as we do now. In addition, we experienced significant membership churn and growth in the Kentucky program during that period.

More recently, as a result of the conclusion of the open enrollment period that ended earlier this month, we anticipate a net membership increase of at least 36,000. Given our uncertainty about these individuals' health conditions and utilization, our outlook reflects a cautious view relative to this membership. As a result of these items, we have reduced our guidance for 2012 adjusted net income per diluted share.

Absent the Georgia revenue issue and our cautious view on the November membership increase in Kentucky, we were tracking toward the lower end of our prior earnings guidance. Our performance otherwise is consistent with our expectations and we will continue to execute effectively on our top-three priorities. I would now like to discuss some of our progress on these initiatives.

We have continued to make meaningful investments in our first priority, which is improving healthcare quality and access. Regarding NCQA accreditation following last spring's strong performance in Hawaii, we are preparing for our Florida review next month. We continue to target accreditation for all of our health plans and anticipate further progress over the next few quarters.

With respect to the recently published Medicare star ratings, while we saw gains in the number of measures, the average of our plans ratings decreased modestly year-over-year. These star ratings are based on 2011 data, so we have known about our challenges for some time and we have implemented targeted initiatives to address them.

We continue to invest in a wide range of activities that are specifically directed to the lower income populations that we serve. Our most recent data indicates progress on closing care gaps and improving operational performance despite the challenges presented by certain characteristics of our membership.

With respect to our second priority, we made further progress this quarter on our disciplined approach to ensuring a competitive cost structure. For the third quarter, our adjusted administrative expense ratio decreased 80% basis points year-over-year to 9.2%. For 2012, we anticipate that our adjusted administrative expense ratio will decrease 100 to 110 basis points year-over-year.

I will now turn to our third priority, which is prudent, profitable growth. Our Medicaid segment member ship increased 15% year-over-year to over $1.5 million as of September 30th, due mainly to the November 2011 launch of our Kentucky Medicaid program. Our service area expansions in the past year have led to meaningful growth in Florida, and we have also experienced growth in several of our other states.

Medicaid premium revenue for the third quarter increased 22% year-over-year to nearly $1.1 billion. We are looking forward to entering the South Carolina Medicaid program through the acquisition of UnitedHealth's Medicaid plan, which is operated in the state for a number of years. The plan currently serves approximately 65,000 TANF and SSI members in 39 of the state's 46 counties. In 2011, the plans were into Commendable Accreditation from NCQA.

South Carolina provides us an attractive Medicaid and Medicare growth opportunity that will leverage our presence in Georgia and is well aligned with our multi-product strategy. We believe the state is making policy changes that should improve the Medicaid program for managed care plans as well as offer the potential for increased membership. In addition, the Medicare Advantage opportunity in the state is significant with nearly 800,000 eligible. Our intention would be to launch MA plans in selected counties in 2014 consistent with our strategy of offering complimentary government programs in all of our markets.

Returning to Kentucky, our membership was approximately 159,000 for September with the recent conclusion of the open enrollment period we expect our membership to exceed 195,000 effective November 1st. We estimate that our 2012 Kentucky premium revenue will be between $675 million and $700 million.

The Kentucky program MBR remained at an unacceptable level during the third quarter. We continue to execute initiatives to achieve a sustainable long-term program by working both, with the Commonwealth and providers. Program modifications that the Commonwealth is implementing including changes to the risk adjustment of rates and retroactively assign member costs are important steps.

With respect to providers, we are executing on unit price initiatives that are appropriate for the market conditions we have encountered. We anticipate further progress by the end of the year. Over the long-term, we continue to believe that the program can operate consistent with our company target operating margin.

We believe that our recent contract award to serve the Kentucky Medicaid Region 3, which includes the Louisville area and 15 surrounding counties, will help us achieve improvement in our overall Kentucky program performance. Our approach to this procurement including our pricing and other elements of our bid, were informed by our experience over the past year.

We believe that the pricing and terms in Region 3, coupled with medical expense reductions and revenue enhancements in the other seven regions will result in a combined program that is stronger and more sustainable. The Region 3 launch is scheduled for January 1, 2013.

In our home state, our new Florida Healthy Kids contract was successfully launched on October 1st. We added over 20,000 new members as a result of our expansion to 65 of Florida's 67 counties, up from 18 counties under the previous contract. This brings our total membership in the program to 83,000 children. The expansion reflects the strength of our provider network, quality initiatives, relationships with community organizations and the value we bring to our customer. More than 230,000 children aged 5 to 18 are enrolled in the Florida Healthy Kids Program.

In the Florida Medicaid program, we continued to expand our service area by adding four counties, Columbia, Flagler, Hardee and St. Johns. We now serve 42 counties across the state. Our combined Florida Medicaid and Healthy Kids membership has increased 10% year-over-year through September.

The Florida Department of Elder Affairs recently approved the expansion of our long-term care diversion program service area from 2 to 19 counties. The program manages home and community based services as an alternative to institutionalized care and reaches as many as 20,000 Floridians across the state.

We continue to look forward to the outcome of the first phase of Florida's Medicaid reform to manage long-term care MLTC procurement contract awards, which were expected in January of 2013.

To wrap, the Medicaid segment, we are pleased to have been selected by our customer in Hawaii to manage the needs of adults who have serious mental illness. Many of these individuals are already our members in the Medicaid ABD program. With the addition of these behavioral health services, we will be able to coordinate care across the full spectrum of diagnosis which will help us to improve healthcare quality and outcomes. The contract is expected to go live in the first quarter of 2013.

Moving to our Medicare Advantage segment, membership ended the third quarter at 167,000, up 29% year-over-year. This is the highest level of MA coordinated care membership in the company's history and we are pleased to be able to serve so many Medicare members.

Premium revenue for the third quarter of 2012 was $471 million growing 25% year-over-year. Our dual special needs plans our DSNP membership grew by 55% year-over-year and those members comprise roughly 35% of our total Medicare Advantage membership as of September of 2012.

We were excited about our recent agreement to acquire easy choice health plan in California. As is the case with our pending acquisition of Desert Canyon in Arizona, this acquisition will provide us with a significant presence in a new and attractive market and will give us a platform for meaningful growth in the large attractive states in the western U.S. across our complementary lines of business.

As of October, Easy Choice serves approximately 36,000 Medicare Advantage plan members in Los Angeles, Orange, Riverside and San Bernardino Counties in Southern California. This includes approximately 12,000 DSNP members making Easy Choice one of the largest DSNPs in Los Angeles County.

Easy Choice has become one of the most rapidly growing Medicare Advantage plans in California by offering attractive benefits and services to both, members and providers. WellCare's and Easy Choice's complementary focus on care management, quality and provider in community relations should enable strong continued growth in the state.

Easy choice has increased is 2013 service area to seven additional California counties, including the San Diego area and five counties in Northern California. More than 60% of California's 5 million Medicare eligibles reside in those 11 counties.

In addition to Easy Choice and Desert Canyon transactions, our focus now is on executing effectively during this year's annual election period and we anticipate solid MA membership growth again this year.

Our benefits and costs sharing terms for 2013 have been designed to achieve what we believe is an appropriate financial rate of return with plans that are attractive to both, current and prospective members.

Our ongoing administrative and medical expense management initiatives are important to helping ensure that we offer competitive products while adhering to our financial margin discipline.

For 2013, we expanded our Medicare advantage service area by 43 counties in Florida, Georgia, Illinois, New York and Texas. We also for the first time are offering MA plans including DSNPs in 10 Kentucky counties.

Our Kentucky Medicaid program current serves approximately 15,000 full duals. Combining this expansion with our Desert Canyon and Easy Choice acquisitions, in 2013, we will serve more than 200 counties in 14 states with over 15 million Medicare eligibles. We are offering DSNPs in nearly all of these counties.

Our PDP membership ended the third quarter at 879,000 and premium revenue for the quarter was $249 million. We anticipate that PDP segment membership will continue to decrease modestly during the remainder of 2012 due mainly to this year's reduced level of auto assignment of low income subsidy beneficiaries.

Our PDP segment has outperformed our expectations this year. In the first nine months, our gross margin increased nearly 40% year-over-year despite the modest contraction in membership and revenue. This performance has been driven in part by the effective positioning of our plans relative to member utilization and cost sharing and our focus on generic medications. These factors make our plans attractive to members who choose a PDP and that group continues to comprise more than 50% of our membership.

Our 2013 PDP bids resulted in our plans being below to benchmarks in 14 of the 34 CMS regions and within the de minimis range of the benchmark in five other regions. By comparison for 2012, our plans are below the benchmarks in five of the 34 CMS regions and within the de minimis range in 17 others.

As a result of the bids, we anticipate a net reduction of 200,000 to 210, 000 standalone PDP members for January 2013 from the reassignment to other plans of members who are auto assigned to us in 2012 and prior years, primarily in California offset in part by additional assignments in other regions. In addition, the decrease in premium rates next year will affect our 2013 outlook for the PDP segment.

While it's too early for us to determine our 2013 enrollment from those who choose a PDP, we are continuing to strengthen our focus on that segment of the population. We have launched a new product that we believe is well positioned as a low cost enhanced plan target to attracting value conscious choosers. As I mentioned a moment ago, over 50% of our PDP members choose WellCare as their Part-D plan.

Now, Tom will review our third quarter financial results and provide some details on our 2012 outlook.

Tom Tran

Thank you, Alec, and good morning. Today, I will first talk about results of our operation for the third quarter of 2012, I will then discuss our balance sheet and liquidity and conclude with some comments about our 2012 financial guidance.

Our adjusted net income for the third quarter of 2012 was $46 million, compared to $93 million for the same period in 2011.

Adjusted net income per diluted share for the third quarter of 2012 was $1.05. Compared to the third quarter of 2011, adjusted net income decreased primarily due to higher MBR for our Medicaid and ma segments. These factors were offset in part by higher premium revenue in the Medicaid and MA segments, the decreases in the PDP segment MBR and the decrease in our adjusted administrative expense ratio.

Premium revenue for the third quarter increased 18% year-over-year to $1.8 billion. Medicaid segment growth of 22% was driven mainly by the Kentucky membership as well as carve-ins of the pharmacy benefits for our New York and Ohio Medicaid programs effective in October of 2011, but partially offset by the Georgia premium reversal.

MA segment growth of 25% result from higher membership, this increase will offset in part by a 6% decrease in our PDP segment premium revenue that was driven by lower membership. Sequentially, premium revenue increased 1% in the third quarter. MA segment revenue increased 3%, sequentially, due to membership growth.

Medicaid segment revenue was flat sequentially, primarily due to the Georgia premium reversal. PDP segment revenue decreased 3%, sequentially primarily due to decreased membership. Our third quarter 2012, Medicaid segment premium was reduced by $18 million, or 1.6% due to an unanticipated isolated issue in the Georgia Medicaid program.

In mid-2011, we negotiated settlement with the state to resolve matters associated with premiums paid on duplicate members. Recently, this settlement was partially disallowed by CMS. The revenue reversal decreased adjusted net income per diluted share by $0.25 in the third quarter of 2012. We continue to believe that the settlement is out and we are in discussions with the state regarding a resolution to this matter.

Regarding premiums, for the Georgia and Florida Medicaid programs, both states are continuing to work toward finalizing the rate change, that were effective July 1 and September 1, respectively. Consequently, our third quarter 2012 results do not reflect any change in premium rates in those two states.

Medical benefits expense for the third quarter increased 28% year-over-year to $1.55 billion Medicaid segment medical benefits expense for the third quarter increased 38% year-over-year as a result of the impact of the Kentucky program as well as membership growth in other programs.

MA segment expense increased 32%, also due mainly to increased membership. PDP segment medical benefits expense decreased 19% over year due to the decreased pharmacy costs, the outcome of our 2012 bids, and the decrease in our membership.

Our third quarter 2012 medical benefits expense include net unfavorable reserve development related to prior periods that decreased pre-tax income by approximately $15 million or $0.22 per diluted share. This includes $8 million of favorable development related to prior years offset by $23 million of unfavorable development related to the first half of 2012.

The unfavorable development experience in third quarter of 2012 was primarily due to higher than expected medical services in our Medicaid segment, particularly in Kentucky. For the third quarter of 2011, we experience net favorable development of prior period's medical benefits payable that increased pre-tax income by approximately $25 million, or $0.35 per diluted share. This development was attributable to medical cost trend emerging favorably, mostly in our Medicaid segment and to a lesser extent in our MA segment as a result of lower than expected utilization.

Our third quarter company MBR was 86.3%, an increase of 6.5 percentage points year-over-year. The primary driver of the increase in the company MBR was the Medicaid MBR, which for the third quarter of 2012 was 91.1%, up 10.7 percentage points year-over-year. The Medicaid increase primarily results from the performance of the Kentucky program, the Georgia revenue reversal and favorable development recognized in the third quarter of 2011. Sequentially, the Medicaid MBR increased 1.9 percentage points due in large to the Georgia revenue reversal.

Regarding the Kentucky program, our third quarter MBR was 106%, including unfavorable development of prior periods claim reserve. The reserve development related to only the first quarter of 2012 and the fourth quarter of 2011, and result mainly from claims being submitted by providers well after the day of service. As described in our news release, we believe a recap of our quarterly result is important to have a better understanding of our Kentucky performance.

On a recast basis, the fourth quarter 2011 MBR was 113%. The first quarter 2012 was 116%. The second quarter was 102%, and the third quarter MBR was 101%. Therefore, we have achieved a 15 percentage point MBR improvement between the first quarter and the third quarters of 2012. That has result primarily from the successful implementation of a number of our medical expense management initiatives. That said, even at the 101%, the third quarter MBR was high and did not meet our expectations.

For the fourth quarter of 2012, we are targeting a Kentucky MBR in the mid-90s for the members who have enrolled in our plan prior to recent open enrollment. We anticipate reaching this target through a combination of our already implemented medical expense initiatives as well as revenue enhancements. For those joining our plan as a result of the open enrollment given our lack of experience with these members, we are assuming an MBR in excess of 100%.

Regarding medical expense, we have been intensely focused on an efficient provider network with an appropriate cost structure. Our initiatives have includes provider re-contracting and terminations, and pharmacy an emergency room cost management.

We also continue to focus on our clinical management capabilities. We have achieved considerable progress in these areas during the past few months. Regarding revenue in Kentucky effective October 1, we received a 3% rate increase. In addition, affected on the same day the Commonwealth change of program risk adjustment methodology to eliminate the cap on the risk adjustment. Also, on October 1, our risk adjustment factor with again slightly positive and modestly higher than our risk adjustment factor for the second quarter.

In summary, while Kentucky has been a challenging implementation, over the longer term we continue to expect the program to operate consistent with our 3% to 5% long-term operating margin target.

For our MA segment, the third quarter MBR was 86.8% an increase of 4.8 percentage year-over-year. Sequentially, the MA segment MBR increased 3.5 percentage points. For the nine months ended September 30, 2012, our MA segment MBR was 83.1%, compared to 81.4% for the same period in 2011.

The year-over-year increase for the nine months period has been driven by increased expenditures for quality improvement in 2012. In addition for the nine months period, we have recognized less favorable development of prior year's claim reserve for the MA segment in 2012 than was the case in 2011.

The MBR for the PDP segment was 64.7% for the third quarter, a decrease of 9.7 percentage points from the same period in 2011, continuing the better than expected PDP performance we have experience throughout 2012. This decrease was due principally to the outcome of our 2012 bids and lower than anticipated pharmacy costs.

Adjusted SG&A expense for the third quarter of 2012 was $165 million, an increase of 8% year-over-year. The increase primarily results from the Kentucky program launched in November of 2011, and to a lesser extent from our growth initiatives.

The third quarter 2012 adjusted administrative expense ratio was 9.2%, down 80 basis points year-over-year. The decrease in our adjusted administrative expense ratio result from increased premium revenue as well as improvements in our operating efficiency, partially offset by costs incurred for growth initiatives. Sequentially, our adjusted SG&A expense increased 12%, and the adjusted administrative expense ratio increase 100 basis points. This is consistent with our historical experience and result mainly from costs associated with the Medicare annual election period.

Turning now to the balance sheet and liquidity. As of September 30th, cash and investment held by our unregulated entities were $350 million, an increase from $168 million on June 30th. The increase result principally from the collection of a portion of the delay premium payments owe to us by the state of Georgia. In addition, during the third quarter certain of our regulated entities paid dividends of $57 million. These in-flows were offset in part by capital contributions to certain of our regulated entities.

Regarding the priorities for our capital. We continue to see from opportunities to deploy capital for growth through organic business development as well as potential strategic acquisitions that could expand both, our product and geographic market.

Turning to consolidated cash flow. Cash provided by operating activities modify for the impact of the timing of receipts from and payments to our government customers was $20 million for the nine months year-to-date in 2012, compared to $177 million during the same nine-month period in 2011.

The decrease in operating cash flow is doing in part to the lower level of medical benefits payable in 2012, compared to 2011 which mainly result from the favorable development we recognized in 2011 and 2012. In addition, 2012 net income has decreased relative to 2011.

Medical benefits payable on September 30th were $671 million, resulting in days in claims payable or DCP of 40 days. DCP increased by two days relative to June 30, 2012. The sequential increase in DCP relates primarily to the seasonal impact the PDP benefit design. Our medical benefits payable remains consistently calculated.

With respect to our financial guidance, we now expect that our 2012 premium revenue, excluding Medicaid premium taxes, will be approximately $7.15 billion to $7.2 billion, a year-over-year increase of 19% to 20%.

Our previous guidance was for premium of approximately $7.1 billion. Growth in Kentucky Medicaid membership and better than anticipated Medicare Advantage growth are the primary drivers of the changed.

We continue to anticipate that the MBRs for our Medicaid and MA segments will increase compared to their respective 2011 MBRs, due primarily to the significantly higher favorable prior period development of medical benefits payables recorded in 2011.

We also continue to expect that our PDP segment MBR will decrease in 2012, compared to 2011, based on a better than anticipated bid and cost performance of that segment. We now expect that our 2012 adjusted administrative expense ratio will be between approximately 8.8% 8.9%, a decrease of 100 to 110 basis points, compared to 2011. Our previous guidance was for the ratio to be between approximately 8.7% and 8.9%. Incremental expenditures for growth initiatives are the primary reason for the change in our guidance.

Combining the elements that I have described as well as some others, we anticipate that our 2012 adjusted net income per diluted share will be in a range of approximately $4.90 to $5.05. Our prior guidance was for a range of $5.25 to $5.45. The decrease primarily reflects the incorporation of our third quarter performance, in particular the unanticipated Georgia Medicaid revenue matter and weaker than targeted Kentucky Medicaid results.

The range reflects uncertainty associated with our Georgia and Florida Medicaid program race as well as the last November increase in our Kentucky membership. As a reminder, we do not include in our guidance any future potential development of medical benefits payable. For the nine months ended September 30, 2012, favorable development of prior year's reserve add approximately $1.12 to our adjusted net income per diluted share.

I will now turn the call back over to Alec.

Alec Cunningham

Thank you, Tom. To wrap up, I would like to make a few comments about our planning for 2013. We will again emphasize our top three priorities improving healthcare quality and access, ensuring a competitive cost position and delivering prudent profitable growth.

We expect another year of solid revenue growth in 2013 resulting from our business development and sales activities as well as recently announced acquisitions. At the same time, we will be investing meaningfully in healthcare quality, acquisition integration and performance improvement and new growth and service initiatives.

We believe the long-term return from these investments will be meaningful. In addition, we will maintain our intense focus during 2013 on ensuring that the Kentucky Medicaid program achieves our financial and operating targets, which of course would have a meaningful impact on our results in comparison to 2012.

All of our Medicaid programs will continue to be challenged by state fiscal conditions, and as we do every year, we will work with our state customers to achieve a premium structure that will maintain managed care program stability while ensuring access to quality cost effective care.

Our PDP segment will be affected by or anticipated decrease in auto assign members as well as next year's reduction in premium rates. The PDP segment has performed exceptionally well in 2012 and remains an important part of our three product strategy.

In closing, I would like to recognize the hard work, commitment and significant accomplishments of our associates, all of which have positioned us well for the future.

Operator, we are now ready to begin the question-and-answer session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is from the line of Tom Carroll from Stifel Nicolaus. You may begin.

Tom Carroll - Stifel Nicolaus

Good morning, guys. Thanks for all the detail on Kentucky. A few questions on that. You mentioned that the mid-90s MLR number you are thinking about for fourth quarter on your, what I guess what I would call, core membership there, mixed in with the open enrollment membership at something higher than that. I guess, could you give us a sense of maybe where you're expecting that number to be on a combined basis. Is it something that's still north of 100%.

And then secondly, what was the negative PPD in the quarter just for Kentucky. To me, it looks something like about $8 million. And then lastly, just longer-term, I wonder if you could give us some sense of when you expect Kentucky to contribute to operating earnings for the whole company. Thanks.

Tom Tran

Hi. Good morning, Tom. This is Tom Tran. So, there are three parts questions there. Let me just chip away at that, so we have been seen roughly about 36,000 member addition effective November 1. We obviously don't have experience for those members and we take a cautious approach to the MBR as we factor that into our earnings guidance for the fourth quarter, so we cautiously look at as over 100%. So, the 36,000 members would generate approximate revenue somewhere between $25 million to $30 million.

So, regarding our core membership up to that point, we have confidence level that we will achieve the mid-90s, so we on a cast base if you look for the third quarter, we were at 101%. We received revenue increase of 3%, so that should take it down below 100%, and that the positive risk adjustment also help us.

In addition, a number of medical cost initiatives that we implemented had somewhat been a slower to get the effected, if you will, due to a number of regulatory process that we had to really go through to make sure that those programs can pass all the required regulation, so we expect that that really kick in effective around September-October, which will also help reduce the MBR quite a bit in the fourth quarter and going forward. So, we feel comfortable with the ability to achieve the mid-90.

Regarding the longer-term, obviously this year a lot of moving parts here relating to the new membership than we have really take a look at in fourth quarter and begin to analyze that, managing that and we are confident in our ability to managed care and manage costs. Obviously, we will be working with the state to ensure that a member that come in are reflective of the potential risk adjustment of that population.

Alec Cunningham

Tom, it's Alec. In the longer-term too as we mentioned that we think the addition of Region 3 is going to be helpful and ready to talk about in 2013 yet, and we don't know what one-one membership will be, but suffice it to say that our bid and our proposal through the Region 3 was informed by the experience over the last year, so in terms of what we've seen in costs and trend and the effectiveness of the medical expense initiatives. So, that should benefit our longer-term performance in Kentucky as well. We will have more detail to share early next year.

Tom Tran

Regarding your other question on the prior period development in the quarter for the Kentucky operations, it was approximately in the $8 million, $9 million to $10 million. So, that's what we provide in the recast, in our news release.

Tom Carroll - Stifel Nicolaus

Great. Thank you.

Operator

Our next question is from the line of Scott Green Bank of America Merrill Lynch. You may begin. Mr. Green. Your line is open, sir.

Scott Green - Bank of America Merrill Lynch

My first questions is on the Medicare Advantage MLR. You talked about increased quality improvement in investment, and I think you said those would persist in next year too. So, my first question is this kind of third quarter MLR in MA be a better indication of the run rate MLR going forward as for making these investments versus the lower MLR in the first half of the year? That's my first question.

Tom Tran

Hi, Scott. This is Tom here. So, in the third quarter we do see significantly higher investment in quality improvement costs. But throughout the whole year 2012, we obviously do have higher QI cost versus 2011, so that was pretty significant in the quarter.

Secondly, if you were to look at also high increase in new members that we have experienced this year, new members typically come in with our risk score to be able to really capture the right revenue, and with the higher influx of new membership, a typical PMPM revenue in the first year is slower, but we typically experience an increase of anywhere from two to three or, four point the following year, so that also has a impact of really to the MBR for the current quarter as well for the year for that matter.

Scott Green - Bank of America Merrill Lynch

Okay. Well, then as a follow-up, how do we feel comfortable if there wasn't so much of a sequential step up in quality investments. That's more of the year-to-date investment. How do we feel comfortable that you captured the increase in the sequential MLR from 2Q to 3Q in your bids next year? It didn't seem like you had materially increased your prices in your MA bids.

Alec Cunningham

Yes, Scott. So, the way we look at this is essentially, we look at a full year today, our MBR is about 83%. Right, so last year it was about 1 point or 1.5 lower, and last year we had obviously more favorable development than this year. So, last year as you look at 2011, we did grow our MA business, but very small. This year when you look at growth in MA is very significance, so that's why the first year premium has the impact of really increase in the MBR a little bit this year.

We are very confident of our ability to really improve the risk score, capture that through SEC was risk score for the second year, so we feel confident about that level. And for the 2013 bids, we obviously factor a lot of these things in there to make sure that we are comfortable with a cost structure, the revenue structure going forward.

Scott Green - Bank of America Merrill Lynch

I am sorry. I was going to ask a second question on a different topic, so I didn't mean to interrupt.

Alec Cunningham

I was just going to underscore the point on the quality. As we mentioned, of course the recently published star scores are result of 2011 data, and so we've had an indication of areas of focus for us through the really the entire calendar years. So, we've had initiatives that we've been investing in since the beginning of 2012, and so we had a good line of sight into the work we were going to do and the cost associated.

Scott Green - Bank of America Merrill Lynch

Okay. That's helpful, and the second question is on Kentucky. Maybe if you could elaborate a little more? Any specific data points would be helpful. I know you said you're going to book over 100% MLR in these new members. Do you characterize it as cautious? But, I guess I see that it's higher, but why is that cautious?

Tom Tran

Sure. We'll have chance of receiving claim data for these members very shortly from the state, but as of today we have not had the luxury of receiving that and analyzing that, so we took a cautious approach to that.

As you know and you published yourself in your analysis that our rates are somewhat higher than the other two plants, but however without the claim experience, the utilization factors, we've really taken a very cautious approach to this and ensure that the guidance reflect our best view of that population today.

Alec Cunningham

Scott, the other thing that I would add, we have had a sense of the number of net adds that we are going to get, but what we don't yet know is where they are going to be coming from. And, as you are aware, the risk scores between plans vary and historically Centene has been lower countries has been higher and we would assume that that's reflective of the underlying medical costs, but until we have better sense of where they are coming from and what the associated risk scores are we've taken a cautious approach.

Scott Green - Bank of America Merrill Lynch

Okay. Thank you.

Operator

Our next question is from the line of Melissa McGinnis from Morgan Stanley. You may begin.

Melissa McGinnis - Morgan Stanley

Thanks. Good morning. I got to first just round out some of the questions on Kentucky. I believe you attributed a negative development in the market till late claim submission from providers. Are you confident that we are now caught up in most claims, or is there still some risk of negative development really that the second quarter, third quarter when WellCare reports out there fourth quarter results?

Tom Tran

Yes. Melissa, this is Tom. Most of these claims as we have comment in our remark came from Q4 and Q1, and we now you have a very good visibility in the claim patterns and we feel reasonably comfortable that the sort of negative development would not happen.

As you know in the first part of the year, we were still in the transition period of time with a lot of hectic implementation quick implementation, so we felt that we have opened a hum on that now and we are confident we have visibility into the development of these claim submission as well as the pattern.

Alec Cunningham

Melissa, remember too that at the beginning of the program for the first several months, there is what the state considers a transition of care window during which we don't have the ability to manage utilization or variety of other factors we would for our network benefits and pharmacy, various other things, but that was a finite window of time and so we had to accept claims during that period from par and non-par providers et cetera.

And so, working through that has taken some time and that reflects some of the numbers that Tom has shared, but that was a finite window that once it closed then we were able to implement our normal protocols for utilization management, network and other things, so that makes it more finite.

Melissa McGinnis - Morgan Stanley

Okay. Great. And then maybe switching focus a little bit. It's great to see WellCare expanding their geographic apparent with some of your moves into Arizona and California and now most recently the South Carolina news. And, looking at the gross margins for some of the Medicaid plans in South Carolina, they have been lower than what we would think typical Medicaid gross margin should run.

Can you elaborate on some of the policy changes you noted in your prepared remarks that you feel like the state is making that seem to provide you comfort that that program will actually become even more attractive going forward.

Alec Cunningham

Sure. There are two primary drivers. One is that the states can be transitioning the membership out of the medical home networks, which is the primary care case management type model between now and the end of 2013, and our sense is that that model has historically received more favorable risk profile. And, so we think pulling those members into the HMO program helps, and then at the same time there's something I think just over 100,000 or so members still on the fee-for-service program that will be brought into the HMO program as well.

So, we think those are two favorable policy developments for us. Then as we said too in terms of that being an attractive opportunity for us, we also like the Medicare opportunity. We think that's a market that we can perform well in and we already have a fairly significant presence in Savannah, Augusta et cetera, and have some the referral patterns are going to be into providers and networks that we've had a multiyear relationship with as a result of our Georgia Medicaid program.

Tom Tran

Melissa, this is Tom. Just to add a little bit commentary relating to the margin. Obviously the margin experienced by companies vary in that market. However, we typically would see somewhere in the mid to at the high end of 80s. And, certainly, that's a reasonable MBR for us to look at in terms of the ability to even continue manage that cost down even further.

Melissa McGinnis - Morgan Stanley

Okay. Great. Thank you for the question.

Alec Cunningham

Thanks.

Operator

Our next question is from the line of Carl McDonald with Citigroup. You may begin.

Carl McDonald - Citigroup

Great. Thanks. I wanted to comeback first to the Medicare Advantage loss ratio. Was there any unfavorable development in this quarter? Just trying to make sure I understand your comments about the new members in the higher loss ratio. Was that you assumed a lower loss ratio in the first half and now you are rectifying that in the third quarter?

Tom Tran

There was some very small immaterial unfavorable development of the MA in Q3, Carl. And, primarily in for years and very, very immaterial.

Carl McDonald - Citigroup

So, if I look at the sequential change in loss ratio on a medical expense basis, it looks like it if you had those same loss ratio in the third quarter that you had in the second. The difference there would have been about $16 million. I am just trying to get a sense if could give us some quantification for how much of that increase is driven by the quality investments versus how much is driven by other medical expense items?

Tom Tran

Yes. Quality investment was, I would say almost half of the increase and that the balance is really as we have high growth in the membership as we comment before which we have analyzed and look at typically with a lower revenue team PMPM at the top, because as you know a lot of these Asia and you don't have risk score during the first year which you can improve in the second year. That has been our historical experience, but we can improve that somewhere in the range of two to four percentage point. That's how we kind of look this for in terms of our ability to improve MBR for that cohort.

Carl McDonald - Citigroup

And, broadening out the last M&A question a little bit, you are requiring the three plans. They generally have a fairly high loss ratio today, so is your anticipation for '13 those deals in total will be neutral to earnings or do you think they can be accretive next year?

Tom Tran

Well, we are not into 2013 guidance at this point, but if you kind of look at South Carolina obviously the MBR is somewhere in the mid-80s to the little bit lower end of the high 80s. And that in California is a little bit different as the plan is heavily a global cap for risk structure, so you have a bit more stability in the MBR. And that in terms of the Desert Canyon, you can also pull all the staff and looked at the that will be in the mid to high-80 as well.

So, in aggregate certainly you can look at as a somewhat higher MBR than our core business today. However, we are confident that we can really have an impact on the MBR and the business will be accretive to us in 2013.

Carl McDonald - Citigroup

Okay. Thank you.

Operator

The next question is from the line of Matthew Borsch with Goldman Sachs. You may begin.

Matthew Borsch - Goldman Sachs

Yes. Thank you and I apologize if you went over this already, but are you assuming an influx of members from Centene if they are able to terminate the contract? Are you having discussions with the state around that?

Alec Cunningham

Matt, as I said a few minutes ago, we know the net number of members that we are getting, but we don't yet have insight into which plan they have come, and so the two are notion of the cautiousness around our forecast. We don't yet know what risk scores that we would associate with that.

Tom Tran

Yes. Matt, on the exit by Centene, which they expect July 1, 2013, obviously as they are still developing their strategy relating to that population, certainly we are in discussion with the state regarding their intent. But at this point, we don't yet know what the state is going to do.

Matthew Borsch - Goldman Sachs

Okay. Maybe with this next one I am also going over ground that you've covered, but it is important on days claims payable reserves or just the reserves generally. How do we get incrementally higher confidence now going forward given the experience that we just had in the third quarter. Wherein hindsight, it's clear that you weren't actually adequately reserved at least for that back in the second quarter.

Alec Cunningham

Yes. As we have commented a number of times in the past, our reserve have been consistently calculated, and reserve reflect the best estimate of point in time, so we feel comfortable with our DCP in the third quarters and much of that development, that unfavorable development that you mentioned was related to Kentucky.

As a new program obviously there were some influx relating to the claim payment, claim submission patterns, but we feel comfortable that we have a good visibility in that now. So, our DCP reflect our best ability to look at in third quarters and we feel that as we commented in the past we don't provide guidance from DCP, but it's really based on change in the business mix that you see and I also want to add another comment if you're looking forward into 2013, with the with the acquisition of Easy Choice for example, which tend to be more global cap, PCP can be even lower than our average today. So, the changes in business mix can have an impact on what we see as the future DCP.

Matthew Borsch - Goldman Sachs

Sure. Understood. If I could just sneak in one last one? What would have been the impact in the quarter approximately had you received the Florida and Georgia the rate increases as originally scheduled. Do you have that figure?

Alec Cunningham

While we don't want to comment on this as they do not want us to comment and rates rise are still under development, so we'll know about it probably sometime in November.

Matthew Borsch - Goldman Sachs

All right. Thank you.

Operator

Our next question from the line of Josh Raskin with Barclays Capital. You may begin.

Josh Raskin - Barclays Capital

Hi. Thanks. Good morning. Just want to reconcile the negative development. I think, Tom, you said $23 million related to the first half. I think you said 9 to 10 with Kentucky negative development, but I think that was both, 4Q and 1Q. So, if you assume half maybe it's like another $18 million or $19 million of negative intra-year development, so where was that. Where did that come from?

Tom Tran

Yes. As commented before, there are some small amount of unfavorable development relating to the MA segment, and then really the balance is really spread in a number of different products in the market on the [K] side.

Some of that had to do with really large claim that we saw, and as you know some of these large claim typically take a while to develop, especially a lot of K markets where they have what they call outlier payments which could take as long as at least six-nine months to really come through and that's when you typically see spread in many different markets. Nothing material by market by itself.

Josh Raskin - Barclays Capital

So, you are saying there has been a spike I guess in these outlier or these large claim, right? Because, you probably have those every quarter, right?

Tom Tran

Certainly, there are fluctuation in these outlier from time-to-time, but nothing that it give us any concern at this point.

Josh Raskin - Barclays Capital

Okay. So, you would just say $18 million or $19 million of general higher development, but nothing that concerns you at this point?

Tom Tran

That's correct.

Josh Raskin - Barclays Capital

Okay. Then as you look at the PDP business next year and understand that you are not giving guidance for '13, but submitted your bid in June. First week of June, you've seen some favorable results two quarters in a row. Is it fair to assume that your PDP margins would run higher than targeted levels next year as well maybe not the same extent or do you feel like in the bid process as you took your bids down that you are going to be at a normalized margin level for 2013?

Alec Cunningham

Well, as you know this year the MBR is unusually low versus what typically experience, and that obviously result from a number of factors one of which is the bids. Second is, a lot of action we have taken relating our pharmacy cost management, and all of that informed information we had really inform us about 2013 bids.

And as you know, the benchmark has really come down quite a bit in 2013. Obviously, you take the PMPM down by a decent number, so we continue to view 2013 to be a good business. We don't want to provide any guidance in this point, but we certainly expect that with a revenue reduction overall, because a loss of approximately 200,000 members going to 2013, the overall top line will come down. That certainly can have an impact on our gross margin.

However, if you kind of look at the California market where we had a lot of the so-called auto assign members that populations tend to have somewhat higher MBR than the general, so our focus has been on developing products that are really targeted to the chooser, which have over the long run can be more sustainable in terms of both persistency as well as a margin.

Josh Raskin - Barclays Capital

Okay. And I understand the benchmarks were down. I think it was 5.8% or so on average, so I was assuming some reversion of margin back to mean, but it doesn't sound like you are going to get back to full sort of long-term target margin. Sounds like you still have a little bit of positive momentum for next year. Is that fair?

Tom Tran

Well, I don't want to get into 2013 guidance now, Josh, but I would say that for the next quarter if we get to it, but we expect the gross margin overall to decrease because the revenue is down. That's what I really meant to say for the 2013.

Alec Cunningham

Josh, to reinforce the point on the choosers, obviously, we are not yet going to know what membership we pick up from Choice until 11 of '13, but over half of our PDP book as you know is choosers and that we feel good about product offerings this year and a low-cost very affordable enhanced product that we think will be attractive to what I described as value conscious choosers, so we are hopeful that that's going to be a success as well.

Josh Raskin - Barclays Capital

Okay. Thanks guys.

Our next question is from the line of Michael Baker with Raymond James. You may begin.

Michael Baker - Raymond James

Thanks a lot. We've obviously seen a pickup in acquisition activity. I was wondering if you could provide some commentary as you look at the pipeline of opportunities and maybe give some sense as to relative attractiveness of Medicaid verse Medicare side at this point?

Alec Cunningham

Sure. As we've said historically, we haven't ruled out any mechanism of growth whether it is organic or through acquisitions, and certainly when an opportunity presents itself were going to look and as we've demonstrated recently when something makes sense we have the capacity to pursue it.

In terms of Medicaid versus Medicare, I would say we evaluate each of those opportunities uniquely, so I have said historically the things that we evaluate on the Medicaid market to bid are a number and that's why not each of them has been a strategic priority, but it would really be an opportunity-specific, population-specific and market-specific evaluation.

Then in terms of MA, we're excited about expanding to the western states and we think we've gotten into some very exciting states in the Western California and Arizona, but we would certainly be interested in evaluating other opportunities that we think make sense.

Michael Baker - Raymond James

Thanks for the update.

Operator

Our next question is from the line of Brian Wright with Monness Crespi. You may proceed.

Brian Wright - Monness Crespi

Thanks. Good morning. With the CMS risk payment, did that occur in the second quarter this year?

Tom Tran

You typically get a first half of your risk score for 2012, and obviously as you know there is a final update going to the following year, so yes that did happened in June of this year.

Brian Wright - Monness Crespi

Okay. And, did there were no?

Tom Tran

As you know that was based primarily on a lot of 2011 history, and that 2012 service will have an impact more so in 2013.

Brian Wright - Monness Crespi

Then last year with that payment third or second quarter payment?

Tom Tran

Well, there are two things. One is an estimate that CMS provide to you and then typically they estimate coming around July timeframe, and then final is really coming in the following year.

Brian Wright - Monness Crespi

Okay. So, last year was the third quarter July and then this year was June?

Tom Tran

Yes.

Brian Wright - Monness Crespi

On the initial?

Tom Tran

Yes. This year the initiative initial was July, and then you can have a final update next year.

Brian Wright - Monness Crespi

Okay. Thank you.

Operator

And, our last question from the line of Sarah James with Wedbush. Please go ahead.

Sarah James - Wedbush

Thank you. So, looking at the current period adjusted EPS, there is $1.5, plus it sounded like from the prepared, Tom had mentioned $0.25 from Georgia and $0.22 of negative development, so that would get me 152 for the current period adjusted EPS. Is that about right axe out of period items?

That's Correct, Sarah. It's axe development and axe Georgia revenue reversal will be north of $1.50. That's right.

Sarah James - Wedbush

Okay. Great. If I was going to annualize and account for Part D seasonality and then improvement in Kentucky, I would just get a number that's north of where consensus is for 2013. I know you guys don't want to speak about numbers, but can you broadly speak to some of the headwinds and tailwinds that you see for next year?

Tom Tran

Well, we won't talk about 2013 right now, but as you know if we were to look at fourth quarter we typically would have higher SG&A, because of the annual election period. That's very normal for us to look at Q4 spend to be higher. And, certainly, we already provided full year guidance, Sarah if you can do the math, it will be somewhere in the $1.30 something after deducting the first nine months.

So, certainly, that's why we feel comfortable given the fact that there are still some things to do play relating to Georgia's and Florida rates. And as we mentioned before, the search in the membership in Kentucky of the last two months of the year.

Alec Cunningham

Sarah, as I said obviously we are expecting a net reduction on our PDP membership as a result of this year's bids, at the same time we are expecting another good year of growth on the MA side. We are working on improvement in Kentucky, but as Tom mentioned too, we expect our state customers to continue to face challenging budgets, so we'll be working with them on the rate development.

Sarah James - Wedbush

Okay. And last question here is on days. Last quarter you gave us a breakdown impact days, the data procedure to date of claims receipt coming down I think it was by about a third and then that was expected to be temporary and then the days of receipt to the date of payment was also down, but that was more sustainable as it related to efficiency improvements, so can you just update us on those two parts as you've seen this quarter?

Tom Tran

Yes. So, the DCP increase for the quarter is primarily driven by seasonality of be a Part D, so I wouldn't into any more detail relating to days of claim receipt versus the date of pay, but I would say that we are back to fairly normal process now.

Sarah James - Wedbush

Back to normal on the first part, which was sort of the more surprising change last quarter?

Tom Tran

Yes. As I commented last time, it was a temporary phenomena for the quarter, but we don't see anything unusual right now for the third quarter.

Sarah James - Wedbush

Okay. Great. Thank you very much.

Operator

Mr. Cunningham, we have no further questions at this time. I'll be turning the call back to you, sir. You may resume with your presentation or closing remarks.

Alec Cunningham

Great. Thank you, operator and thanks to all of you for participating in today's call, and we are looking forward to speaking with you early next year. Have a great day.

Operator

Ladies and gentlemen, this does conclude the conference call for today. We thank you all for your participation. Have a great day, everyone.

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