Coventry Health Care's CEO Discusses Q1 2012 Results - Earnings Call Transcript

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Coventry Health Care (CVH) Q1 2012 Earnings Call April 27, 2012 8:30 AM ET


Drew Asher - Senior Vice President of Corporate Finance

Allen F. Wise - Executive Chairman and Chief Executive Officer

Randy P. Giles - Chief Financial Officer, Executive Vice President and Treasurer


Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

Joshua R. Raskin - Barclays Capital, Research Division

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Scott J. Fidel - Deutsche Bank AG, Research Division

Carl R. McDonald - Citigroup Inc, Research Division

Douglas Simpson - Morgan Stanley, Research Division


Good morning, and welcome to Coventry Health Care's First Quarter 2012 Earnings Conference Call. Today's conference is being recorded [Operator Instructions] Today's call will begin with an opening remarks by the Chief Executive Officer of Coventry Health Care, Mr. Allen Wise, after a brief forward-looking statement read by Mr. Drew Asher. Please go ahead Drew.

Drew Asher

Ladies and gentlemen, during this call, we will make forward-looking statements. Certain risks and uncertainties, including those referenced in our press release and described in the company's filings with the SEC on Form 10-K for the year ended December 31, 2011, may materially impact those statements and could cause actual future results to differ materially from those anticipated and discussed. Allen?

Allen F. Wise

Good morning, and thank you for your interest in Coventry Health Care. Earlier today, we reported the best quarter in the history of our company both in terms of revenue and earnings per share. Q1 revenue was $3.7 billion, and that's up 21% from the first quarter of last year. And earnings per share of $1.20 driven by strength across 6 of our 7 businesses, especially our Medicare Advantage business.

As you can see in our current Medicaid medical loss ratio, we have some serious work to do in our recently added Medicaid business, but all of Coventry's other businesses: Commercial, Medicare Advantage, Medicare Part D and our Fee-based businesses were on track or ahead of plan for the quarter. With regard to SG&A, we posted a very strong result with the rate of 13.6%, which is down 280 basis points from the first quarter of 2011.

Today, I'd like to touch on each of our businesses and share with you our current perspective and probably more importantly where we're heading. And let's start with Medicare. The strength of the quarter in terms of Medicare Advantage was primarily driven by 3 factors: a very successful open enrollment season, which resulted in sequential membership growth of 13% or 28,000 members; the second was a very favorable outcome from the risk adjustment data validation audit process pursuant to methodology changes issued by CMS during the quarter enabling us to reduce our related reserve that we've built over the last several years; and third, strong operating results in Medicare Advantage even absent the operating earnings driven by the RADV reserve release.

I believe it's worth a moment staying on Medicare Advantage. We operate Medicare Advantage Health Plans in 15 states, 14 of these states growing coming into 2012. We're pleased with the momentum of this business and expect to continue to expand our footprint and membership base over the next few years. We have taken what we believed was a prudent posture over the last few years and accruing our best estimate of RADV liability even in the absent of perfect clarity.

The update in guidance from CMS were able to reflect the reduction in the RADV reserve of $133 million or $0.58 per share contributing to the strong Medicare operating results in the quarter. This is important for a couple of reasons. First of all, it should give you insight into the prudence in reserving for this type of exposure, which I believe was not necessarily consistent industry wide. And perhaps more important, we were able to substantially reduce a headwind in our Medicare Advantage bids since we'll now adapt to the updated CMS RADV guidance.

As we look ahead, this along with strong execution and performance of our Medicare business to continue to support the competitiveness of our Medicare Advantage products.

Other Medicare business, Part D, also had a very good first quarter. Coventry has a national Part D footprint and is #5 nationwide in market share. As you may recall from the open enrollment period coming into 2012, we're able to expand our auto-assigned footprint from 15 to 23 regions and launched a third product with a preferred network creating attractive value proposition for seniors. And the results were very satisfying. We grew 28% sequentially in the first quarter 2012, adding 315,000 members. Our Part D medical loss ratio is consistent with prior year Q1 and on track for the first full year forecast of low to the mid-80s of medical loss ratios.

Our combined and Medicare business represents approximately $4.3 billion of annual revenue or about 30% of the company's total revenue. From our perspective, Medicare has an attractive growth and margin profile and we're off to an excellent start in 2012.

Moving on to our Fee-based businesses, Coventry's diversified across 3 business signs: Workers' Compensation service, federal employee administration and Rental Network. Our Fee businesses produced over $1.1 billion in free revenue with higher-margin characteristics than our Risk business. First quarter of 2012, was slightly ahead of our previous plan and as you can see, we increased our forecast of fee revenue for the full year. These Fee businesses are important part of our diversified portfolio and they generate strong earnings with unregulated cash flow.

Moving onto our Commercial business. We continue to focus on building and signing new contracts for high performance networks, as I've covered last quarter. Regardless of the outcome of reform, we believe driving to a low-cost structure will best position Coventry, enable us to create products to provide a compelling value proposition for both employees, for both individuals and employer groups. We currently sell Group commercial products through our health plans in 25 states. We spent the last 6 years developing individual products and capabilities, and currently sell individual products alongside our historically strong Group products in all of those states.

The gaining factor for Coventry entering a commercial market, either organically or through acquisition, is cost structure. Many cases a network components of cost structure is a key asset in an acquisition and often negotiated as a part of the transaction. In other cases, we're able to use a collective set of company assets including our locally-based health plans and other national businesses to maintain a top tier cost structure in existing markets and negotiate favorable cost structure in new markets. We expect our high performance networks to play an important part in both the existing and new markets.

Ultimately, we look forward to seizing growth driven by the Health Care Reform jump ball, or quickly adapt if Health Care Reform course changes.

Nimbleness and local marker intelligence through our Health Plan presence has historically been a key strength in our commercial Health Plan business for at least 15 years. We expect our efforts will position us for success regardless of the direction of Health Care Reform.

I'm moving on to Medicaid. Our Medicaid business has experienced significant growth coming into 2012. We're currently in 10 states carrying members in program spanning temporary aid in needy families, age blind and disabled, bills and CHIP members. Coventry has helped states manage Medicaid populations and programs since the early days of state-based managed care adoption over 1.5 decades ago. Our Medicaid experience in solutions certainly contributed to Coventry's successful pre-procurement of Missouri, our largest state presence in terms of membership which was announced by the state of Missouri during the first quarter. In addition, we look forward to adding to our position in Nebraska later in 2012, based on the win discussed in our last conference call.

We also today have some news to report on the Medicaid RFP front. This week, our Pennsylvania subsidiary Health America, was awarded 2 letters of intent to contract which will cover new managed care regions in Eastern and Western Pennsylvania. As you may recall, we already have a Medicaid footprint in South Eastern and Southwestern Pennsylvania. The Commonwealth of Pennsylvania selected 4 carriers in the West for a targeted effective date of September 1, 2012, to manage approximately 165,000 eligibles. Three carriers were selected in the East including Health America for a targeted implementation date in Q1 2013 to manage approximately 215,000 eligibles.

So as a result, we look forward to serving our share of the 380,000 members when these programs go live.

Our mature Medicaid business performed consistent with our expectations for the first quarter. With respect to our new Medicaid businesses, as you will recall, close to Family Health Partners acquisition on January 1 of this year, which our results reflect the first few months of our ownership there. I'm pleased with our relationship with Children's Mercy Hospital in Kansas City, key partner in providing quality care to children in Missouri and Kansas. As you would expect, this relationship was certainly an important element of the transaction. The integration of the acquired business is on track 3 months post closing and the successful procurement outcomes in Missouri was a very good start to this acquisition.

Our remaining relatively new Medicaid business is Kentucky, which is for us producing very negative financial results. Actually we're getting our tails kicked. Kentucky is in early stages of a 36-month contract, which was effective November 1, 2011. Now that we have 5 months of data, it's clear that our poor financial results really result from 3 areas: 1 of which was anticipated and 2 of which were not. First area is a result of adverse risk selection. How did this happen? Well the RFP which we responded to and all other bidders responded to, required a robust list of contractor providers in all 7 regions in order to bid. If the response was inadequate in any one of the 7 regions, responding companies would've been eliminated for all regions. Coventry responded to this stringent standard and compiled in all regions, even though the provider cost and health status of the Commonwealth of Kentucky citizens is more challenging in regions 7 and 8. Not all companies selected responded in the matter that we did but were nevertheless allowed to participate in all regions. And the result is what you would expect, which is we received a disproportionate number of members with high utilization enrolled in high-cost systems. Our company also exacerbated our problem by being the only carrier not to require copayments in pharmacy.

In the RFP, the Commonwealth of Kentucky committed to an appropriate risk adjustment mechanism to adjust or partially adjust for adverse risk but at this time, we've been unable to obtain their commitment for compensation which would address the adverse risk selection as required by the contract that we have with them. As discussion is ongoing and while we cannot be specific as to the timing, we feel that these discussions will be successful.

The second and unanticipated area was at least one error from the Commonwealth's data book when we bid the business with regard to pass-through payments to hospitals for medical education. This was clearly an oversight by the Commonwealth and while we have not been able to attain agreement from Kentucky at this time, on this front, we believe we will ultimately be successful and obtain adjustment for these hospital pass-through payments.

Third area is the basics of managed care, which was anticipated. How do we take better care of members in a more cost-effective manner? It was expected and we now have the data to address the basics of approved care for the members and the initiative necessary to control costs and improve care. These areas include pharmaceutical abuses, mental health issues, too many non-par providers and so many other areas. We are currently working on about 50 initiatives, which will deliver value to the Kentucky Medicaid program and improve outcomes for the members.

Bottom line, we're confident our discussions with the Commonwealth of Kentucky and our medical initiatives will make this a viable program for the future. Hopefully you've listened carefully to our discussion about Kentucky as we will not entertain any questions on this subject during the Q&A portion. We're obviously in ongoing discussions with the Commonwealth of Kentucky in many areas as well as many providers and it would be inappropriate to talk about details of these discussions in this forum.

One more thought on Kentucky. It's important to reiterate that the population previously operated in a completely unmanaged arena. And I'm not only talking about the members but also physicians especially vendors, pharmacies and so on. I want to assure you that we put all the resources of the company to bear the work with the Commonwealth on appropriate solutions such as proper risk adjustment and fair and equal treatment on implementing the dozens of healthcare initiatives that should bring medical cost down perspectively. More resources in our company are focused on finding the proper long-term solution, make it financially sound and workable while improving the care for the members. But while we work on improvements in Kentucky, our other diversified businesses continue to perform well and we're seeking out another selective growth opportunities across our broad set of businesses.

Our balance sheet is in excellent condition as I referenced in the last earning call with the reduced level of debt. And we currently have $900 million of deployable cash on hand as of March 31, as well as an untapped credit facility of $750 million. At our regularly scheduled board meeting in mid-March, we spent time on capital deployment avenues including M&A, share repurchase and for first time in the company’s history, our board approved a dividend to complement these other methods of delivering value to our shareholders. Those of you who were shareholders as of March 23, should have received your first quarterly dividend on April 9.

While the level of cash generated in our businesses and our capitalization, we believe we continue to deliver value to shareholders and M&A share repurchase while also providing for dividend that today analyzes to approximately $70 million.

Recap our first quarter capital deployment activity we closed an acquisition, paid down $234 million of debt and declared our first shareholder dividend. We are planning to continue with the share repurchase program beginning in Q2 at level somewhere 2012, absent any compelling M&A opportunities or other usage. While we will evaluate and react each quarter to needs and opportunities, we are committed to a continuation of capital deployment. I'm really pleased with the positioning of our diversified set of businesses and the resulting opportunities that we should be able to seize over the next few years in Medicare Advantage, Medicaid, bill eligibles and potential opportunities in the commercial market.

In addition to the company's organic opportunities, we'll also selectively deploy capital to grow our business footprint. The benefit of having a set of well diversified businesses and a strong balance sheet, is a strength which allows us to invest in new opportunities and survive the challenges that new ventures often bring. While I'm disappointed in the early start to the Kentucky contract, we will continue to seek new Medicaid opportunities along with growing our other businesses to bring the long-term value necessary for owners. And with those comments, I'll conclude my part of the presentation and our Chief Financial Officer, Randy Giles, will take you through the financials. Randy?

Randy P. Giles

Thank you, Allen. This morning I want to begin by discussing our consolidated performance in the first quarter and then spend the remainder of my time reviewing our first quarter results and full year outlook for each of our key businesses. GAAP earnings per share for the first quarter was $1.20, which includes the $0.58 benefit from the release of reserves related to RADV as Allen described in his prepared remarks and $0.62 of earnings generated by the company's operations excluding the RADV item.

As you saw on this morning's earnings release, our full year GAAP EPS guidance range is $3.10 to $3.30 inclusive of favorable impact of the RADV reserve release as well as other updates that I will detail further in my commentary this morning.

It's important to note that this guidance range does not reflect the impact of anticipated share repurchases in 2012, beyond those required to hold share count flat was where we ended 2011. Our consolidated revenue guidance now exceeds $14 billion at the midpoint with the similar mix of business roughly 40% commercial, 30% Medicare, 20% Medicaid and just under 10% being other. As in our previous guidance, we're reflecting movement to a more balanced mix over 2011. This strategic diversification across a balanced portfolio of businesses gives us a flexibility to adapt to today's fluid regulatory environment and seize opportunities across the products spectrum.

The results for the first quarter of 2012, were characterized by performance meeting or exceeding our expectations in 6 out of our 7 core businesses, with an outstanding result on SG&A as our cost control efforts coupled with leveraging top line growth continue to bear fruit for the organization. Our Q1 revenue of $3.7 billion puts us ahead of our prior guidance range and drove the increase to our full year guidance midpoint $14.1 billion in revenue, which would be a record revenue level for the company reflecting a significant acceleration in the company's growth rate over 2011.

Starting with the Commercial business. First quarter MLR of 79.9%, keeps us on track for our full year MLR guidance range of 81% to 82%. This is consistent with the 81.6% result that we reported for full year 2011, which was the first year impacted by minimum MLR regulations. We are currently projecting total Commercial Risk revenues of just under $6 billion for the year, the individual business expected to generate approximately $425 million of that total. The remaining Group risk revenues are expected to be split roughly 40% small group and 60% large group, consistent with the mix that we saw in 2011. We currently estimate that approximately 25% of our Commercial Risk revenue is in a rebate position today. We will continue to evaluate strategies to effectively utilize rebate capital by providing more value to our customers; improving the attractiveness of our products; promoting quality initiatives with hospitals and physicians to improve HEDIS scores; and initiatives to reduce future Healthcare cost.

Staying at our commercial book, our view of fundamental prospective trend remains unchanged in the range of 8%, plus or minus 50 basis points. In the rearview mirror, we are seeing trends in the high 7s and have continued to migrate higher from the very low levels seen during the second half of 2010 consistent with what we shared with you last quarter. Again these trends include the impact from the healthcare reform regulations implemented on September 23, 2010, which are fully incorporated into the current period but are only partially included in the baseline.

Unit cost trend, which continues to be the largest driver of overall trend is stable. As we look at trend by component, in the first quarter we saw a slightly negative trend for inpatient days per thousand and we're projecting inpatient utilization trends to be flat to slightly positive prospectively, which is consistent with our prior prospective view given the historically low comparison levels that we're seeing during 2011.

Utilization trends that we are seeing in the outpatient physician categories continues to show signs of a slight increase similar to what we observed over the last 2 quarters, both remaining in slightly positive territory. This migration from negative outpatient physician utilization trend to slightly positive, has been gradual and has been anticipated in our pricing.

Before I leave the Commercial business, there's one other item that I would like to highlight this morning. In the first quarter, we signed a binding term sheet with Magellan's NIA subsidiary [indiscernible] expanding our strategic partnership, radiology management services. This term sheet renewed agreements that were set to expire in the near-term, restructured the overall terms of the agreement and significantly lowered our capitative medical cost for this category of service.

Moving on to government programs. Our Medicare results for the first quarter were driven by outstanding performance during the annual election period which I'd like to highlight in a little more detail. Starting with Medicare Part D. We solidified our #5 [ph] national market share with the third highest absolute growth in the industry and the second highest growth on a percentage basis among our large peers as our innovative new product First Health Value Plus enrolled approximately 375,000 members, increasing our total Part D membership to $1,158,000 at quarter end. We like our positioning for 2012 and expect to continue to grow Part D membership throughout the remainder of 2012.

We're also pleased with enrollment results for our locally-contracted Medicare Advantage products as we added 28,000 new members, which was the third best percentage growth among our large competitors and included growth in all but 1 of our 15 states increasing total Medicare Advantage Membership to 250,000 members at quarter end.

Our Medicare Advantage MLR of 74.1% reported or 82.9% for the quarter, excluding the favorable impact from RADV reserve releases, was clearly a very strong start to the year consistent with our full year MLR guidance excluding RADV impact in the mid-to low 80s. These results were supported by mid-single digit reduction in days per thousand from the prior year quarter. Our Medicare part D results for the first quarter were also strong in terms of growth and our MLR of 94.9% keeps us on track for our full year MLR guidance in the low to mid-80s.

I will now discuss our Medicaid business in detail as we saw MLR pressure in the first quarter that I want to address and also talk about some of the initiatives that we're working on to improve these results throughout the remainder of 2012. First, let me remind you that we have Medicaid business in 10 states today with total Medicaid Membership of 924,000 at quarter end, which has increased by 97% from the prior year quarter as we work towards our goal of enrolling 1 million Medicaid members.

With the exception of the ramp-up in Kentucky, our Medicaid business is performing well both in terms of organic membership growth and MLR performance. Allen already outlined some of the challenges that we are experiencing in Kentucky which I would like to now elaborate on.

Our outdated guidance incorporates a projection for Medicaid MLR in the mid-90s for the full year, increased from our previous guidance of approximately 90% driven entirely by Kentucky. As we discussed in the fourth quarter of 2011 earnings call, the Commonwealth of Kentucky quickly transitioned a highly unmanaged Medicaid population to managed care beginning in November 2011.

When Coventry bid on this business, there was always an underlying assumption that projected taking historically elevated to spending levels and through the implementation of traditional managed care protocols an improvement of patient care reducing both excessive utilization and wasteful spending over time. This process has been more challenging than we had forecast, as our reported MLR in the first quarter 2012 of 120.9% was higher than what we recorded in fourth quarter of 2011. I would like to reiterate Allen's comment that we are very disappointed in this outcome, and have focused many of the company's most senior executives on addressing the situation. We have also strengthened management on the ground and continue to add significant resources. For reasons that I'm sure you understand I cannot get into specifics on the discussions that we're having with the Commonwealth, but let me broadly outline for you what we are doing both in terms of the revenue side as well as on medical cost initiatives.

On the revenue side, we're in discussions with the Commonwealth around the appropriate mechanism for risk adjustment payments as stipulated in our contract. At this point, it also remains unclear whether these payments will be made retroactively to the contract inception date or whether they will be prospective only.

We're also working to address certain data book errors, for example around supplemental payments which would more properly match our revenue with underlying cost structure dynamics of this contract. And finally, as we've disclosed previously, we have a 5.3% rate increase which will take effect on October 1 of this year.

On the expense side, our management team and some of our top clinical professionals from other areas of the organization are fully engaged in implementing more than 50 real-time ongoing action items based upon emerging data to address higher cost areas.

It is clear that pharmacy and behavioral health cost, in particular, are exceeding our previous projections. Now that we have a stable population based, we've been able to more effectively deploy our solutions for these specific pressure areas.

As an example, the run rate of pharmacy costs should benefit from an ongoing increase in generic utilization, as well as 4 major branded drugs converting to generic during 2012. We've also developed initiatives to address areas which appear to have questionable prescribing patterns which is all part of turning an unmanaged program into managed care.

We have similar initiatives covering network construction; provider profiling and collaboration efforts; fraud and abuse; an increased pre-authorization process; increasing member cost-sharing and so on.

During the first quarter, the rules around transitional care from the unmanaged period ended. We are now able to implement processes to improve care coordination and manage cost. Also in the first quarter, the reimbursement level for non-par providers was reduced from 100% of the Kentucky Medicaid fee scheduled to 90%.

We have an extensive list of other initiatives as well, covering all categories of healthcare expense. They are being worked on every day and evaluated by senior management. Though all these are not things that we can turn around immediately, we expect continued improvement during 2012, as we resolve matters with the Commonwealth and bring run rate cost down based upon the initiatives outlined above. We're absolutely focused of rectifying this isolated situation.

Before I conclude my Medicaid commentary, I would like to highlight the 75% of our membership which resides in states other than Kentucky that is performing well both in terms of financial results, in terms of seizing growth opportunities. In the last earnings call, we highlighted our contract award in Nebraska, where we will have the #1 market share and be the only participant with a statewide presence when that contract commences in the third quarter of this year.

We also announced a new contract in Pennsylvania commencing during the second quarter as we were awarded entry into the Southwest region of Pennsylvania's Medicaid program, Health Choices. We began enrolling new members on April 1, and that region expect to gradually grow our market share there through auto assignment similar to our growing presence in the Southeast region. I'm excited to announce that on the heels of our launch in the Southwest region, we were just notified recently, as Allen mentioned, that we have been awarded significant new letters of intent to contract in both the New West and New East zones of Pennsylvania as well with total Medicaid eligibles of approximately 380,000. The New West contract is expected to commence in September with the New East contract beginning in March of 2013. They're not expected to have a material impact on our financial results for 2012.

While our win in Missouri was not necessarily a new business, I'm very pleased that our Medicaid team was able to retain our #1 market position in that state including the recently acquired Family Health Partners business which represents our largest presence in terms of membership today.

Now moving on to our Fee-based businesses. Our updated guidance incorporates an improved view of management services revenue driven by higher than expected revenue from our Workers' Compensation business as well as better volumes in Health Plan ASO. The increase in our guidance for the cost of sales line item reflects a portion of growth that we are seeing Worker's Compensation services. Our Fee businesses are an important part of our product portfolio strategy providing diversification from our large risk-based business with valuable unregulated cash flows and are an area that we intend to grow and invest in prospectively.

Our SG&A results for the quarter and corresponding full year guidance reflect the continued progress that the company is making towards driving a low cost structure that we believe is the most critical component of Coventry's long-term strategy.

For the first quarter, we reported SG&A expense of $502.9 million or 13.6% of revenue driven by careful management of headcount and other cost even as we continue to grow the top line revenue. In addition, we are seeing increased traction in our broker pass-through strategy, the Commercial Group business which has a beneficial impact on our SG&A expense levels.

Our revised full year SG&A guidance midpoint of 14.9% of revenue is an improvement of 160 basis points from 2011. It is particularly satisfying when you consider the additional expense that we are incurring for compliance with new healthcare regulations, investments in our recently added businesses, as well as increasing investments that we're making for future growth.

The full year guidance includes our normal assumption for an elevated level spend during the fourth quarter related to the Medicare AEP, as well as typical January 1 renewal expenses for the Commercial Risk business.

As you saw on this morning's press release, our cash flow from operations for the quarter was $420.5 million or 246% of net income. These results include the receipt of an extra payment from CMS in the quarter as well as a positive adjustment related to the RADV reserve release. So after adjusting for these items, our cash flow from operations was $123 million or more typical 139% of net income.

Moving on to our balance sheet and cash flows. Our investment portfolio remained in a high-quality position for the first quarter with the net unrealized gain of $100 million at March 31, an increase from $97 million at the end of 2011. At the end of the quarter we had $900 million of deployable free cash that's apparent, consistent with the level that we disclosed in our prior earnings call which was as of January 31.

As usual, during the second quarter we'll begin our annual regulated subsidiary dividend process. The first quarter was quite an eventful one on the capital deployment front. To begin, we closed the Family Health Partners acquisition early January, then we paid off our $234 million of senior notes that came due later in the month. Finally on March 12, the company announced our first dividend in its history which was subsequently paid on April 9.

As Allen mentioned, we are also committed to point capital per share repurchase beginning in the second quarter and targeting levels comparable to 2011. It's important to note that our EPS guidance range does not include anticipated share repurchases in 2012, beyond those required to hold share count flat where we ended 2011. Acquisitions remain our top priority for use of our cash with a recent dividend initiation in commitment share repurchase reflecting our goal of maintaining a well-balanced capital deployment strategy.

Our debt to cap is at a very reasonable level 25.2% at quarter end. We have an undrawn $750 million credit facility that isn't scheduled to expire until 2016, which combined with our free cash of $900 million provides capacity of $1.65 billion and significant financial flexibility as we evaluate perspective opportunity.

So in conclusion, I'm encouraged to see significant progress being made across all of our businesses as we work towards our 2012 financial objectives and position the company for tomorrow. We have tripled our projected revenue growth rate from the prior year. And we've added more than $700,000 new members as compared to the prior year quarter. I'm personally focus on identifying the right investments for the future, pursuing growth opportunities across our portfolio businesses, and improving the financial performance of existing businesses to strengthen the company to produce long-term value for our shareholders. Operator this now concludes our prepared remarks, and we are ready to open the lines for questions.

Question-and-Answer Session


[Operator Instructions] We take our question from Tom Carroll with Stifel, Nicolaus.

Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

I have a high-level question on Medicaid. If I back out Kentucky, it seems that your other Medicaid markets are operating in the high 80s in terms of an MLR and if I combine that with the comments you made today, is a high 80s MLR a level we should think about for Coventry's Medicaid business in kind of 2013 and beyond? And then secondly, more of a smaller market question, I know it's a small market for you but the Maryland Medicaid plan has seen some slowing growth. Is there opportunity to maybe divest that business and focus elsewhere or try to improve it? What's up there?

Randy P. Giles

This is Randy. As far as our target for Medicaid MLR long-term, we think that's can be run in the mid-high 80s. So that would be our target for long-term to answer that question. As it relates to our Maryland operation, we really don't discuss kind of our outlook on M&A activities around our existing businesses. But we're looking to grow all of our existing markets. We've actually, in some of our smaller markets, had some good recent expansions. We're actually expanding in one of our smaller markets in Virginia recently. We're expanding the Southwest Virginia, so we're looking to grow those businesses and evaluate each one on the standalone basis.


And our next question comes from Josh Raskin with Barclays.

Joshua R. Raskin - Barclays Capital, Research Division

I understand Allen, you're effort to sort of avoid talking about the negotiations with the state, but I was just wondering if you could sort of help us just from a technical standpoint, when did you realize that this was an issue? You're locked in for sort of a 3-year period from a pricing perspective but is there ability to simply cut bait and walk at any point? And then I guess the other issue, in terms, in my mind, it looks like you're already implying just from a financial standpoint, it looks like you're already implying improvement in the next couple of quarters and it sounded like you didn't think there'd be immediate impact on your actions, so I'm just kind of curious what's driving that improvement as you move forward?

Allen F. Wise

I think as to the win, so if our reserves in November and December are consistent with my comments, we knew that going from a dead start, cold start to manage the population was going to take some time. I think that as we started to getting data in the first quarter, and I would characterize that as being late February, we became aware of the disproportionate membership in high-cost regions -- both high utilization and high-cost regions -- so in the late part of February, we became much more knowledgeable about what our problems beyond just managing the population was. When you go from a dead start, I think the lessons learned here is that I would be reluctant to participate in any new initiative that's pushed through a 90 to 120 days with only 60 days or so to prepare for the population. Those are lessons learned. But I think that the 50 initiatives that we have on the healthcare front, on the healthcare management front will -- are beginning and will begin to show some improvement, which is part of the reason for a guidance for the rest of the year. I think the number of providers that have more data on who's more efficient as opposed to less efficient, we will be refining that process. That will bring improvement through the year. And ultimately, consistent with my prepared comments, I think that we will be successful in reaching an accommodation with the Commonwealth consistent with the contract that we signed. So it's ugly but it's going to get better and that's about what I can say about it.

Joshua R. Raskin - Barclays Capital, Research Division

Okay, and then just one quick question on the Kansas Medicaid Award. Could you help us size your current exposure there in terms of revenues and I guess if you even, if you want to give some commentary around profitability relative to the overall book?

Allen F. Wise

We're in the middle of the discussion process with the state of Kansas now and I think there will be some clarity on where all that leads in the next 30 to 60 days. We don't have anything today that's remotely definitive. We're in the middle of discussions.

Joshua R. Raskin - Barclays Capital, Research Division

I guess just -- I was just asking how big is it currently?

Randy P. Giles

It's about $350 million in revenue. And about 150,000 members.

Joshua R. Raskin - Barclays Capital, Research Division

And the profits on that business are similar to your overall X Kentucky?

Randy P. Giles

Well it's a brand new acquisition through FHP and it's performing to our expectation. It's not where it's going to be as a long-term but...

Allen F. Wise

For what we know, after 90 days.


We move now to Charles Boorady with Crédit Suisse.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Just a few points for clarification because your comments were very fullsome and helpful in Kentucky. First, you talked about the issue with competitors not living up to their contractual obligations regarding service areas and I wonder, it sounds like that caused you financial harm and I just wonder what remedies you might have there against those competitors or is it really an issue you see with the state?

Allen F. Wise

Well I think, it's the first issue is the state didn't hold everyone accountable to the requirements of the RFP. We did what we usually do, we complied in good faith and some of the people didn't. The remedy is of course there is the contract has a risk adjusted revenue remedies and that's data that's being discussed with the Commonwealth as we speak. So there is a remedy or at least a partial remedy in the contract to adjust for the higher risk population. So that's part of the solution. I think that half of our problem roughly is revenue base, which we believe is supported by the contract and that we will receive some relief. Can't be specific as to when and half of it is what we understood when we went in a state like this, we had some previously unmanaged population with a bunch of work to do.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Okay. The risk adjuster, how much did you accrue for assumed risk payments in the first quarter?

Randy P. Giles

We didn't accrue anything.

Allen F. Wise

We didn't accrue anything because as I've discussed with, I think with clarity, is that we have no resolution with the Commonwealth and we don't accrue anything until the checks clear.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Okay. So even though it's in the contract that you would be owed this risk-adjusted payments until you actually receive the cash for them, you're not accruing the expected receipt. Is it in your guidance from mid-90s?

Allen F. Wise

That's consistent with this company's practice ever since I've been the CEO. And let's get off of Kentucky now because any details would be counterproductive to our discussions with the Commonwealth and with providers in the Commonwealth.


We go now to Scott Fidel with Deutsche Bank.

Scott J. Fidel - Deutsche Bank AG, Research Division

Allen, I just had a question in terms of just your comfort levels more broadly on Medicaid right now, in terms of taking on so much additional growth given the challenges that you're seeing in Kentucky. Just particularly given your discussion about how much management resources on the Medicaid side that you want to put into Kentucky and the 50 initiatives that you have going on there. How do you feel about management then within Medicaid right now to address all the other expansion that you have going on?

Allen F. Wise

If you think about Medicaid, we have a 15 year history going back to 1994 in Missouri. In the early -- in the late '90s, we had some places that we withdrew from, Florida when rates were arbitrarily cut by a lot and the Delaware at one time. So the company went through a period of time where we were sort of, not sort of, where we were holding and doing what we have but not very aggressive in pursuing new opportunities. When I came back to the CEO spot in January of 2009, I thought the world had changed a lot in 4 years, so we began developing resources and hopefully expertise and started putting corporate resources in the growing of business for the future. And Nebraska was the first bid that we won on that front and I won't go through the history. We have most recently within the last quarter brought Tim Nolan, whom I've known for 25 years on our business and who's in the very successful reinvigorating our Commonwealth of Pennsylvania business in his years and along with Maryland and Delaware in the years in the past, and so we have continually added people and added resources. And so strategically, I think it's a good business. I think it's like all of our other businesses that you're going to have to get better that we used to be. I think there's margin pressure on all of our businesses so you have to have best people and best business practices. So I think Kentucky was certainly an expensive education but we're learning as we go. We've proven I think that we can compete for new business with everybody else. And I think on the government front with this Medicare Advantage Part D, I feel the same way about Medicaid that we have the structure, we have the better people than we've ever had. We are continuing to learn. We're continuing to do a better job taking care of the population. So it's a part of our future and in spite of a little blip along the way, or a big blip along the way, we're undaunted and we think that there's a lot of opportunity. We're going to continue to put resources in that revenue source.

Randy P. Giles

Just to add to Allen's comments. I'd like to differentiate Kentucky a little bit from some of the other markets we're expanding like Pennsylvania and the other expansion opportunities that are in the intermediate term for us. Those expansion opportunities including Nebraska and Pennsylvania are in states where we have existing Health Plan business, existing resources and we have existing Medicaid business. We have capabilities and people already, and assets already deployed in those states. So as we think about the expansion opportunities in those areas and now with our FHP acquisition, potentially in Kansas, we have assets and we've acquired assets where we already have health plans. We have a huge commercial business in Kansas already, so I look at Kentucky as a different situation where we were going into a state where we actually had no resources on the ground. But in these other situations, we actually do have resources and we have expertise with Medicaid in those states already.

Scott J. Fidel - Deutsche Bank AG, Research Division

Okay. Then just had a follow-up question just on your view of trend and first, Randy, just to clarify did you say that you thought was sort of running in the high 7s on the look back basis in 1Q. And maybe just now that you've had a lot more claims come in for the 4Q, just interested in sort of how you view -- how trend progress sequentially from 4Q to 1Q '12 which obviously there's not as much claims experience on at this point?

Randy P. Giles

Our view on trend is really unchanged from the fourth quarter. As we look at prior period development and how that's developing for the last year, it's coming in stronger than 2010 at a higher level. So we feel good about kind of our trend forecast and where we peg that. And trend is really very similar, our views are very similar to fourth quarter. We don't see a change in that outlook at this point in time.


Our next question we'll go to Carl McDonald with Citi.

Carl R. McDonald - Citigroup Inc, Research Division

Could you talk about how you think about premium deficiency reserves and when the right situation to use one is and when not?

Randy P. Giles

Premium deficiency reserves obviously work with our accountants and around the individual contracts and look at the entire contract period as required. And we look at those on individual contract by contract basis. And if that make sense or another situation, we look at our entire block of business. So we look at that, we evaluate that every quarter and we make an assessment and we work with our auditors and have them review our analysis and that's the way the process works.

Allen F. Wise

If that's specific to Kentucky, which we don't know at this -- we don't know what the revenue is until we reach a decision with the Commonwealth and I don't know that after 5 months that you exactly have a close handle on the medical expenses you will 3 months from now. So when you have all the facts if it's appropriate, along with the in way, that's what we'll do. We don't have all the facts yet.

Carl R. McDonald - Citigroup Inc, Research Division

Okay. And then a quick follow-up. It looks like the change in the Medicaid loss ratio, if it's all related to Kentucky pushes up the Kentucky loss ratio 1,600 basis points give or take. What is your assumption for the Kentucky loss ratio that you've embedded in the guidance?

Randy P. Giles

We don't really break out contract specific guidance around individual loss ratios. I'll comment on the deal kind of increase and our MLR guidance for the Medicaid line is related to Kentucky.


For our final question, we go to Doug Simpson with Morgan Stanley.

Douglas Simpson - Morgan Stanley, Research Division

Just to beat a little bit of a dead horse here. As we're thinking about Kentucky, maybe a different way to look at it if you think about that, call it 15, 16 points on the MLR that will be implied if you attribute the entire $0.58 to the premium associated with Kentucky. How would you characterize your expectation in the balance of the year? If I heard you right, you're not including any incremental pass-through receipts or anything on risk adjuster front. Is it kind of correct to think about the seasonality that we would have expected as of yesterday and then burden each quarter by that roughly 15, 16 points on the MLR? Is that -- would that get us in the right zip code in terms of thinking of seasonality and the contribution from Kentucky?

Allen F. Wise

I think we can't do much more than we've done, which is, say, half of it is a revenue base that we're in discussion. The other half is medical initiatives. We explain that we have 50 initiatives going, that we're also refining our provider system there and concentrating more on the membership and where we're going to get a better result. I don't think that we can predict day by day or week by week. But we know the cumulative effective of medical management will improve our position as the year progresses. We know that we have a large revenue increase coming October 1. So when you add the discussions up, the medical initiatives, the revenue we know that we're going to get, we're going to go from a terrible picture to an improving picture as the year progresses and that's about as good as we can do at this particular point. I think that Q2 will bring clarity to the resolution with the Commonwealth. And I think that Q2's going to bring us some clarity, the 3 more months of data or medical initiatives where they're starting to work and with the revenue. This won't drag on with so many unanswered questions for the entire year. I think that Q2 will bring a partial answer to what the rest of the year looks like.

Douglas Simpson - Morgan Stanley, Research Division

Okay, and then I may have missed this, I apologize if I did. Randy, did you say that how the RADV benefit was treated on the income statement?

Randy P. Giles

It was an increase to revenue.

Douglas Simpson - Morgan Stanley, Research Division

Okay. Just drop it right into the revenue straightaway?

Randy P. Giles



Ladies and gentlemen, that does conclude today's question-and-answer session. I'd like to turn the conference back over to Mr. Wise for any additional or closing remarks.

Allen F. Wise

No, we don't have any additional remarks and thank you so much for joining us today.


Ladies and gentlemen, that concludes today's conference. Once again, thank you for your participation.

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