Humana Inc. (HUM) Q2 2011 Earnings Report, Transcript and Summary

Good morning. My name is Ryan, and I'll be your conference operator today. At this time, I would like to welcome everyone to Humana's Second Quarter 2011 Earnings Release Conference Call. [Operator Instructions] Ms. Nethery, you may begin your conference.

Good morning and thank you for joining us. In a moment, Mike McCallister, Humana's Chairman of the Board and Chief Executive Officer; and Jim Bloem, Senior Vice President and Chief Financial Officer, will briefly discuss highlights from our second quarter 2011 results, as well as comment on our earnings outlook for 2011. Following these prepared remarks, we will open up the lines for a question-and-answer session with industry analysts. Joining Mike and Jim for the Q&A session will be Jim Murray, our Chief Operating Officer; and Chris Todoroff, Senior Vice President and General Counsel. We encourage the investing public and media to listen in to both management's prepared remarks and the related Q&A with analysts. This call is being recorded for replay purposes. That replay will be available on the Investor Relations page of Humana's website, humana.com, later today. This call is also being simulcast via the Internet, along with a virtual slide presentation. For those of you who have company firewall issues and cannot access the live presentation, an Adobe version of the slides has been posted to the Investor Relations section of Humana's website. Before we begin our discussion, I need to cover a few other items. First, our cautionary statement. Certain of the matters discussed in this conference call are forward looking and involve a number of risks and uncertainties. Actual results could differ materially. Investors are advised to read the detailed risk factors in this morning's press release, as well as in our filings with the Securities and Exchange Commission. Today's press release, our historical financial news releases and our filings with the SEC are all available on Humana's Investor Relations website. Finally, any references made to earnings per share or EPS in this morning's call refer to diluted earnings per common share. With that, I'll turn the call over to Mike McCallister.

Good morning, everyone, and thank you for joining us. This morning, Humana reported second quarter earnings of $2.71 per share, an increase of 35% over the $2 per share we earned in the second quarter of 2010. Looking ahead to the remainder of the year, we raised our full year EPS guidance to a range of $7.50 to $7.60 per share from the previous range of $6.70 to $6.90. This increase primary reflects lower projected benefit expense ratios in our Retail and Employer Group segments. These are partially offset by new reinvestment spending in Medicare sales and marketing and related Medicare investments designed to improve the companies Star ratings processes and the clinical initiatives that make up our 15 percent Solution. The essence of this is that we believe the second quarter's favorable results, along with our planned additional investment spending, positions us well for further growth, a midyear approach similar to last year's at this time which, as you know, proved successful. With the 2012 Medicare annual election period just around the corner, my remarks this morning will focus primarily on opportunities to expand our 2012 Medicare Advantage and Medicare PDP membership a little more aggressively than we thought possible 90 days ago. As we've shared with you over the past several years, we worked constantly to research and understand seniors' changing needs and craft a value proposition that's differentiating and compelling. This value proposition includes, among other proprietary elements, integrated care, performance-driven metrics for care providers and actionable information for the members themselves. One of the things we've learned about seniors that doesn't change from year to year is their desire for stable benefits and premiums. For 2012, as has been the case for the past few years, we've been fortunate enough to be able to build such stability into our offerings, a genuine competitive advantage. On top of that, the results we announced this morning bode well for an excellent 2011 and give us the latitude to accelerate the kind of investments likely to produce an even better 2012. To illustrate, I'll describe 2 of these reinvestments in a little more detail. First, with Medicare Advantage payment grades tied to Stars quality scores beginning in 2012, we plan to reinvest heavily in improving our Stars processes, procedures and infrastructure to position us for further improvements in Stars metrics. Humana believes deeply in paying for performance, the essence of the Stars program. Solid and growing evidence in terms of better health outcomes and lower costs indicates that paying for performance injects necessary productivity and accountability into a dysfunctional healthcare system that has been characterized for years by too little of both. Second, our innovative Humana Cares program that focuses on members with multiple chronic conditions currently helps more than 100,000 people. Armed with data which tells us we can help more people while it also makes good business sense to expand our reach, we intend to do so. As I've discussed with you in past earnings calls, these seniors have improved their health and well-being while using fewer health resources with the guidance of Humana Cares nurses, other medical professionals and the network of community service agencies. By spending more to build out this program, we anticipate offering Humana Cares to an additional 25,000 members. Although specific reinvestment plans are already being formulated, we will have the ability, if necessary, to modulate our plans as the competitive landscape becomes clear in early October. As always, we anticipate our Medicare growth coming from a variety of sources, including an increasing number of agents, still a long-term opportunity in Group Medicare accounts. And again as always, we will share with you in our third quarter call preliminary membership growth projections for both Medicare Advantage and PDP. Before closing, I want to touch briefly on 2 recent strategic milestones. First, our partnership with Reader's Digest, which we announced in May, is moving along nicely. This alliance is similar to our successful partnership with Wal-Mart in an important way. It links Humana to a powerful, national, well-recognized consumer brand that resonates powerfully with seniors. Reader's Digest brings 2 vital strategic elements to the relationship: a vast senior database that reaches 80% of all Medicare eligibles and nearly 90 years of expertise publishing easily understood health and wellness information that seniors worldwide have come to trust. Humana and Reader's Digest will be developing a series of co-branded Medicare products from Humana that we expect will debut later this year. Second, last month, we launched HumanaVitality, our joint venture with Discovery Holdings of South Africa, the global leader in integrated science-based wellness, rewards and loyalty programs. The groundbreaking HumanaVitality initiative, available now to all our Commercial members, unites a number of strategic principles that we have emphasized for the past decade and which are responsible in large measure for our success during that time: consumerism, actionable information, data, guidance, innovation and customized incentives based on actually sound models and the idea of making healthy things fun and fun things healthy. Going forward, we believe HumanaVitality will become an increasingly vital component of our dream of helping people achieve lifelong well-being through the long-term, personalized relationships involving a wide variety of health enhancing Humana products and services. With that, I'll turn the call over to Jim Bloem for a detailed analysis of our financial results.

Thanks, Mike, and good morning, everyone. Looking first to the quarter, we were pleased with our earnings of $2.71 per share. As indicated on the slide, the primary reason for the substantial improvement over the midpoint of our previous earnings per share guidance was attributable to operations, which contributed $0.51 per share of the $0.66 per share increase. Approximately 85% or $0.44 per share of this better-than-expected operating performance was driven by lower benefit expense ratios for both our Medicare advantage and PDP businesses, thanks largely to our 15 percent Solution. The remainder was primarily attributable to the continued moderate medical cost trend environment in the Employer Group segment. We will review each of the 3 financial reporting segments in a minute. But before we do, let's briefly look at the 3 nonoperating items which in the aggregate comprised $0.15 per share of our $0.66 per share better than the previously anticipated second quarter earnings. First, higher period favorable medical claims reserve development added $55 million or $0.21 per share to our second quarter results. $33 million or $0.13 per share of this amount was attributable to prior years, while $22 million or $0.08 per share related to the first quarter of this year. We will further break down the prior-period development by segment shortly. Second, we also booked a second quarter expense of $23 million or $0.08 per share in connection with the Limited Income Newly Eligible Transition or LI-NET program. This adjustment results from a retrospective review of our contract with CMS and reflects the amount of gain sharing that we expect to pay CMS based on our solid operating metrics and performance to date. Third and finally, second quarter share repurchases and a slightly lower tax rate together added $0.02 per share to our previously forecasted second quarter earnings per share. Turning next to our financial reporting segment. We have increased our 2011 full year Retail segment pretax income forecast by approximately $80 million. To break this full year Retail segment improvement further down, approximately $120 million relates to the better-than-expected second quarter operating performance of our Medicare Advantage and PDP businesses. An additional $38 million is from favorable prior-period development, principally from Medicare Advantage. The remaining $22 million reflects the operational progress that is expected to continue into the second half of this year, net of the strategic Medicare investment spending that Mike described in his remarks. Based on our experience over the last 5 years, we strongly believe these investments will further benefit us, both in the short and long terms. Turning next to the Employer Group segment. We have increased our full year 2011 forecast by about $57 million. Approximately $20 million of the better-than-anticipated second quarter total operating performance improvement was due to the continuing low utilization of medical services by Commercial group members, with another $17 million coming from favorable prior-period development in the Employer Group segment. The remaining $20 million of additional increase in Employer Group pretax income guidance reflects our improved forecast for the second half of the year based on our favorable first half results. As I mentioned, we continue to experience a moderate medical cost trend environment with levels of utilization lower than historical norms. For pricing purposes, we continue to expect that trend levels ultimately will revert to more normal levels. Moving next to the Health and Well-Being Services segment. We've lowered our forecast for the year by approximately $35 million. There are 2 things to note here. First, approximately $15 million of the $35 million is related to our RightSource pharmacy business, which has experienced greater than expected price erosion from generic drugs due to, among other reasons, the recent availability of multisource alternatives. While this price erosion both reduces our revenue and pretax income forecast for the Health and Well-Being Services segment, there is an offsetting benefit in our Retail and Employer Group segment forecast. Accordingly, on a consolidated basis, our full year 2011 earnings expectations are not adversely affected by these lower generic prices. Second, as Mike described, we plan to further invest $20 million in Humana Cares, HumanaVitality and other clinical infrastructure that pay -- that play a significant role in our 15 percent Solution. Again, based on our multiyear experience, we believe that further investments of this type will continue to generate long-term value for our Medicare members, the Medicare trust funds and our shareholders. Finally, consolidating these segment details, we've increased our pretax guidance range for the year by approximately $180 million or $0.75 per share, including $0.08 per share for year-to-date share repurchases and a slightly lower tax rate. Accordingly, this morning's increased full year EPS guidance range represents a growth rate of 16% to 17% over last year, a clear demonstration of the operating effectiveness that our associates strive for every day. With that, we'll open the phone lines for questions. [Operator Instructions] Operator, will you please introduce the first caller?

[Operator Instructions] Your first question comes from the line of Matt Borsch from Goldman Sachs.

If you could just talk to us a little bit about the Medicare Advantage agents and how you're doing given that, I guess, this year represents the first cohort of baby boomers? Just particularly interested if you see a change in the attitudes as evidenced by enrollment towards Medicare Advantage versus traditional Medicare.

This is Jim Murray. We like to think about growth from a lot of different channels and opportunities. The agent growth is doing well for us. The one thing that I would point out, though, is that because of the economy of late, I would suggest that agent opportunity is probably a timing issue for us and others in the business. More people are staying in the workforce past age 65. And so although with the baby boomers and the aging that we've shared with you in the past, there appears to be a bit of a timing item respect to people coming into the Medicare program. But overall, as you can tell from today's report, we feel very good about all of our growth prospects, including Group Medicare and other forms of enrollment opportunities.

Yes. Okay, great. That makes sense. And on the Commercial front, can you just give us a quick take on where you think -- see things, in terms of competitive pricing at this stage?

Sure. As we've talked about in the past, there appears to be more competition in the over 100k size. We would point to our HumanaOne in our small group blocks of business that are growing nicely, and large group for us is an area that we haven't been growing of late. There isn't one particular competitor that seems overly aggressive. It just seems like because there's more of an opportunity for companies to negotiate in those k sizes, it looks like that's an area where it's a dog fight day in and day out. We feel very good about our overall Commercial book of business. But the large group, over 100k size seems to be an area that's more competitive than others.

Your next question comes from the line of Charles Boorady from Credit Suisse. Charles Boorady - Crédit Suisse AG: Can you speak specifically to the Medicare components of medical trend?

Sure. This is Jim again. The Medicare for us, as we've told you time after time, we generally assume about a 5% secular trend for Medicare. And then when we do our bids, we build in what we call trend vendors, which really represents our anticipation of the improvement on the 15 percent Solution. And then as the year plays itself out, and we've done this now for 3 or so years in the past, we see improvements on our margins because our 15 percent Solution is being affected and that seems to be the case again this year. Charles Boorady - Crédit Suisse AG: And so specifically, can you talk to which initiatives may have had a meaningful impact? Or was it more a combination of many different initiatives that bent the cost curve in the Medicare Advantage business?

We've shared the 15 percent Solution with you in the past. It includes a number of different elements. It includes identifying the right providers to be a part of our networks going forward. It includes the Humana Cares, which Mike referenced earlier and the ROIs that we're beginning to see on that. It includes nurses in the field doing case management work for folks who are in the hospitals or skilled nursing facilities. It's negotiating of contracts with ancillary providers. It's a culmination of a lot of different things that we feel pretty good about our focus on.

Charles, this is Mike. I've been saying for the last couple of years that I was really beginning to see an emerging better capability around the integrated clinical activities across all the things that we do, and I think we continue to see that. So I think it will continue to get better. And the lack of value for money in Medicare and the way the old program works is so awful that it just sets up a great opportunity for us to rationalize and get better value for the members, for us and everyone else. And it just -- and I've never been more optimistic than I am today around our ability to continue to get more traction there. Charles Boorady - Crédit Suisse AG: You've talked about the duals being one of areas with the greatest opportunity, $300 billion a year on 9 million lives. And in light of the budget deficit reduction talks going on, do you have any sense for what to expect for duals moving into Medicare Advantage versus Medicaid HMOs and anything you're doing as a company to prepare for migration of the duals?

Yes. Boy, if they are really on their game in Washington, they will try to find a way to get all of these people into some form of managed care because -- and we have a lot of these dual eligibles today that came largely through the Medicare Advantage door. And we can see what's going on there, and it's just that everything I said in my previous comment is just exacerbated when you're talking about dual eligibles. So a big opportunity to get better care for this people and to save a lot of money in the process. So I think at the end of the day, if they get serious about this, they're going to have to take a look at these people and see how they're going to get them into managed care. We are interested in that. We've been at it for a while, and we're watching carefully as to whether that's going to go through the Medicaid door or the Medicare Advantage door and our intention is to be prepared for either. So I expect us to have an enduring membership over time in dual eligibles.

Your next question comes from the line of Justin Lake from UBS.

I just wanted to, I think, given we are past the June deadline for bids, just your early thoughts on your 2012 Medicare bids given medical costs appear to be higher here. What are you kind of thinking for that -- first that typical 5% margin you assume in Medicare on how 2012 might shape up?

First of all, I disagree with the costs being higher statements you made, Justin.

I apologize if it's not higher.

Okay. Now that we're straight, here's a bit. I would characterize our bidding as -- we kind of had it in my comments that we were fortunate based on everything that's been going on that we could be pretty stable with our benefits and our premiums for next year across most of the country. So I think we're positioned perfectly for what next year can bring to us from a growth perspective. Having said that, we never know exactly where we're going to be until we see all of our competitors' specifics come in October. But barring something wildly unusual in the marketplace, I would expect 2012 to be a good growth year for Medicare, both Medicare Advantage and PDP.

Great. And then just quickly on capital deployment. It was great to see you get off to a strong start with the share repurchase. Can you tell us whether you think this a good run rate to assume, this $200 million a quarter for purchases going forward and whether there's any thoughts as to including some level of share repurchases in forward guidance, as most of your peers do?

Yes, generally, Justin, we don't do either one. Basically, we look at it opportunistically. We look at all of the things we're looking at in the pipeline for capital expenditures, for M&A, whatever else that we're working on. And then we also look at what's going on in the market with respect to the specs. So it's better for us to have a very discretionary program like we have in the past and continue to do that. And I think that serves our shareholders and helps us, again, balance all the ways we can deploy capital, including the ways that add to the business.

I would to add that we don't consider share purchases to be strategy, so we tend to be opportunistic with it. We've committed to doing it over the next 2 years. You know what the number is. We will do that, but the timing of that would be opportunistic in nature for us.

Your next question comes from the line of Josh Raskin from Barclays.

Just wanted to talk a little bit more about the specific investments that you're making in the Health and Well-being segment. You guys talked about the, I guess, good position that you're in, allowing you to accelerate some of these costs. So maybe just some specifics on what you're doing additionally in that 15 percent Solution and then as you talked about the Star bonuses, maybe where you are today versus where you want to be in the future.

This is Jim Murray. I'll give all of what the investments that Jim referenced in his remarks, and I won't talk about any dollars. But generally speaking, what we are attempting to invest in, in the third and the fourth quarter, you can break those investments into 3 buckets. The buckets would be growth. The second bucket would be Stars and quality initiatives. And then, the final would be clinical infrastructure. From a growth perspective, we were pretty successful last year with some brands then that we did right before the AEP, and we anticipate accelerating that based upon what Mike talked about a moment ago with what we saw when we were able to finalize our bids. We're also focusing on direct-to-consumer spending and accelerating that to the lifetime value calculations that we do. Because of what we're going to do there, we anticipate that we're going to need more market point reps throughout the United States, somewhere between 300 and 400, in pockets that we think have opportunity for us. And then, as you grow that membership above where we had anticipated, we're obviously going to need service folks to service the new membership. So that would be the category on growth. Under Stars and quality, preventative messaging, accelerating some of what we're doing to get folks to take better care of themselves around the HEDIS measures is where we are going to spend some dollars. Many of you know that the bonuses are in part -- significant part, based upon service metrics and so doing some things to add folks in our service infrastructure to drive some of those better results so that we can improve our bonuses and quality. This next category is an area HRA welcome call, reengineering and risk adjustment FTEs. We see a real opportunity to do some reengineering around our initial contact with our new members, identifying risk adjustments information and also finding out more about the folks in terms of what we can do to intercede in preventative measures. And we're doing some reengineering work there, and we're going to invest. And then finally, in the Stars and quality area, EMR investment. You may have seen some press releases that we've done here recently with companies like Allscript and Athenahealth and others where we're trying to get a lot more information in electronic medical records going forward, in line with what the government's doing. We think there's a real opportunity there. And finally, in the clinical area, the Care Hub, something that we talked about with all of you in the past. Our clinical messaging system and workflow system, more rules, engine and accelerating IT spend there. Mike talked about hiring more Humana Cares nurses throughout the United States, field nurses throughout the United States in areas where we anticipate growing. And then finally, we did some work here recently to in-source all of our DM programs, and we're going to accelerate that because we're seeing some nice results there. So that's all the investments that we are anticipating for the third and the fourth quarter, lots of focus going forward.

Great. Got you. And then just one quick follow-up on the bids for 2012. I think, Mike, you said you're expecting good growth in the PDP. So I was just curious you guys have seen some really strong growth there. Any region specifically where you had to make some changes in your bidding and any anticipated regions that could see a slowdown in the growth?

Well, it could be hard to grow as fast as we just grew because we introduced a whole new product with our relationship with Wal-Mart. That's kind of an unusual event. But I would argue nothing dramatic around the country relative to offerings or geographies. That's kind of my whole point. Things are pretty green light here, and we're going to have a lot of stability. And it's going to be really strong in terms of retention and lowering churn. So all of that gives us a fair amount of confidence in what next year's going to look like.

Your next question comes from the line of Kevin Fischbeck from Bank of America.

I just wanted to clarify a point that you made about how the quarter today both for a good 2011 and accelerate the kind of investments to produce an even better 2012, is that a comment about enrollment or a comment about earnings being better in 2012 versus 2011? Well, you guys are likely to beat your 5% margin when you talk about a 5% target margin next year, just that could be the delta between the 2. But do you feel good about the earnings being up next year?

I was primarily talking about enrollment, but the 2 tend to go together. I mean, we do reset our margin each year, and this year we set that at 5%. We do that. And then fortunately, we continue to work on it, and we're working already on what next year's trend is going to look like as we sit here. So the bids we are putting there, 5 overall. We've said that. We do that way, and then we go about trying to do better than that. And so far in each year, we've been able to do that. So we're not going to guide our earnings or a specific enrollment today. But my growth numbers -- comments were more toward enrollment than anything else.

They do tend to run together, though.

All right. That sounds good. And I guess, maybe then just going back to the trend comment. Obviously, everyone expects trends gets back to normal because that's what normal is. But are you actually seeing any evidence at this point that trend has started to accelerate versus where it was in Q1?

Your thought with that last question is more Commercial than it is Medicare. We've said for a long time that Medicare seems to be different than the Commercial because it doesn't appear like the economy is negatively impacting secular trend for Medicare. But for Commercial, we continue to do well relative to where we have thought the trends were going to be. We haven't seen any evidence yet that the trends are starting to uptick. But in terms of our pricing, we constantly always make sure that we price with secular trends in mind because this is a temporary situation, we believe. And we want to be priced appropriately if it were to return back to the previous levels.

Does your view on the better performance on Medicare MLR is not really, in some sort of industry-wide phenomenon, it's more execution on that 15 percent Solution?

That's what we believe, yes.

Your next question comes from the line of Tom Carroll from Stifel, Nicolaus. Thomas Carroll - Stifel, Nicolaus & Co., Inc.: More specifically on your new PDP product, the low priced Humana Wal-Mart item that you introduced this year. Could you provide maybe some more color on what changes, if any, you've made for the products in 2012? It's been very successful. And then just secondly, in your slide deck you provided today, your second half operating improvement expectations are much less than first half. So I'm just looking for perhaps what's the primary driver of that conservative view, maybe it's all the investment items you just spoke about. But if you could, chat about that.

I'll start with the Wal-Mart answer. It falls into my broader category of earlier statements that the stability and benefits in prices is where we are with that, so no drama there. But we'll have another year where the relationship matures and people grow more comfortable with it, and so I think it's going to continue to be a good growth opportunity. And the second part of that was?

Why is there difference in earnings for the second half?

The second half earnings. And again, you indicated investments, and that's correct.

Your next question comes from the line of Chris Rigg from Susquehanna.

So clearly, upbeat comments about product design for next year. And I guess I'm just trying to get a sense for, are you -- is there any reason to believe why we shouldn't see enrollment gains at least equal to what we've seen so far in 2011? Or do you think 2011's numbers growth is running above what we should expect normally in Medicare Advantage side?

Well, we're not going to get specific, but we're not using the term strong growth. It wouldn't consistent with the reduction in membership growth for next year. So I think directionally, we can get comfortable that it will be a good year.

Okay. And then I guess this is more -- I think, last quarter you had said -- is there still a $0.10 earnings headwind in your numbers related to Penn Treaty?

Yes, there is. And it's in the fourth quarter.

Your next question comes from the line of Christine Arnold from Cowen.

Two quick questions. First on Group Medicare, could you -- how do you express how that's going? I think a lot of the government agencies do a lot of that kind of midyear, July to October and then also corporations tend to move, I think, in January. How is that going for you and compare it, if you wouldn't mind, to this time last year? And then with respect to Medicare, am I understanding your comments correctly that you expect growth in MA and PDP to be greater in 2012 than 2011? Or are you just saying you expect strong growth?

So I'll take the first part. This is Jim. We're in the processes, as you referenced, of bidding on a number of Group Medicare opportunities, both government and businesses. And I would suggest that the pipeline that we see this year is better than the pipeline that existed last year. There seems to be more interest in taking company or organizations' retirees to an MA program. I think those larger customers are beginning to get a sense that there's a longevity to the program and they feel more comfortable putting their retirees with companies like us. And we're seeing the uplift in the pipeline, I think, as a result of that. As to the growth, I'm going to let Mike handle that one again.

Let me try it one more time for those of you who did not ask this question. I mean, it's -- always remember that we're not going to see what our competition's got until October. And so when we talk directionally today about where we're going with growth next year, we try to connect a couple of things for you. One is we're spending some serious investments in the latter part of this year to prepare for an environment based on what we have done ourselves that looks quite good. And so that's what we're talking about here today. I mean, if we all turn our cards over in October and we've had competitors do crazy things, then things can change. And that's why we're not guiding to anything specific today. But when we do it in the third quarter call, we'll be able to get quite specific and we have a history of being pretty accurate with these projections. So I feel pretty good about what we're going to be able to do then. But I'm just signaling today that barring something unusual, we should have a good '12 in Medicare and that is why we're willing to spend the money we're preparing to spend in the latter part of this year to prepare for it. It's a nice opportunity.

Okay. And then on the Group side, is it you independently getting these group accounts? Or is it the CIGNA relationship you think firing off here?

The CIGNA relationship is a part some of the cases that we're bidding on. But more, I would suggest, are us without the CIGNA relationship.

The next question comes from the line of Sarah James from Wedbush.

I wanted to speak a little bit more about your provider strategy. First, of the 3 million members that live near a Concentra clinic, how many at one point could be served by a captive clinic? And over what time period could you see that happening? And then second, if you could touch on your strategy for expanding the number of clinics, where could the number be in 2 to 5 years? Are you thinking about that as more organic or M&A? And would they also be located in work sites, or are you considering stand-alone facilities?

Yes, I'll start, and I'll let Jim fill in the holes. Again, we don't look at our Concentra delivery assets as some sort of a broad geographic national solution to network needs and that sort of thing. What we have is a nice opportunity to be opportunistic about situations relative to geographies, the need for urgent care centers. We're working through a detailed strategy at this point around how to approach each market with a combination of Concentra capabilities, risk sharing relationships where they can be done, medical home models. I mean, I think we're in an era right now where this whole idea of how primary care networks and physician networks more generally are going to be built is a work in progress because of all the dynamics in the marketplace with doctors getting together and hospitals buying doctors' practices and all of that. So again, I'll come back to we bought the capability to respond to a number of needs in the marketplace relative to doctors. We have a big opportunity in Medicare advantage which we constantly talk about, and I think we're going to, over time, get very good in integrating what Concentra can do in that business. And to the extent we're looking at acquiring things, I don't expect things of this scale to be a part of that because they don't really exist out there. So I think it will be much more opportunistic and probably market by market. But it's probably -- it's not probably, it is going to be an ongoing strategy of the company to continue to grow the capabilities to respond to doctor needs, market by market.

Yes. The only thing that I would add to what Mike said, I think, was identifying the different relationships that we'll have market by market. Some of them will be with outsiders who are willing to accept risks and some will be with our own Concentra assets and our focus on creating rich arrangements and incentives and quality delivery in a lot of markets. The one thing that I would add real quickly is we see -- also see an opportunity to merge the Concentra work site capability with some of the health and wellness assets that we have here at Humana. Mike referenced earlier in his remarks the Vitality program and then many of you know that we already have the LifeSync and Hummingbird assets that are focused on health and wellness. So we see that as a tremendous growth opportunity in our Commercial lines of business, and we're also pursuing that with the Concentra acquisition. So we're excited about that as well.

Okay. And it looks like SG&A was guided up about $91 million to $92 million. How much of this increase is marketing versus Star ratings. And where do you stand with Star ratings as of today? I think as of the last release, you had about 581,000 in a 3.5 star and about 300,000 in a 3-star segment.

Right. Let's do the Star ratings first. We had 274 last year. We have 311 is our average or overall Star rating. And again, as Jim mentioned, one of the aspects of the spending that you're mentioning is going to attempt to enhance that. So as we look forward -- looking forward into how much of the spending there really is, you're right. By looking at the admin ratio or the operating cost ratio, there's just around 100. But if you go back through the different ranges that we provided with respect to the improvement in MER or benefit ratio in both the Commercial and more importantly in the Medicare part, you can see then that what falls out of there is a total spend number that's probably in the range of 180,000. So the range of all the spending, again, and Jim said we weren't going to get into that and we can't at this point because we haven't seen what the competitors are doing, but we've given you a good description of what we're spending the money on. So I've used that range, 100 to 180, in looking at the total investment spend for the year.

Your next question comes from the line of Peter Costa from Wells Fargo Securities.

Can you tell me, in your Medicare advantage membership, how many members did you drop this year due to nonpayment of premiums and things like that?

I don't have that exact figure.

Peter, it's going to generally be the difference or it's going to be the primary difference between where we are now and what we've projected for the year.

So these drops haven't taken place yet as of the . . .

Because they would be in the third quarter.

They were dropped in the third quarter, okay

Yes.

Right, you can see that's pretty tight, that we've build that the increase guidance that we've given and where we are is pretty consistent to where we are right now.

And does that mean you no longer plan to drop as many as you were before?

That's what I was just going to say. It hasn't turned out to be as much as we had originally thought as we started the year.

Okay. And then can you tell us that if there's been any update in terms of the RADV audits in terms of the timing of when that's going to come out? And also with such a strong quarter, did you think about taking a reserve for some of these other charges that may have ended up showing up?

No, to the second part because we can't take a reserve for an uncertainty, especially one as big as this. So in terms of uncertainty, I would argue that we don't know any more than we've known all along. I mean, I've heard all the rumors and things out there and some of you have talked about things or written things. At the end of the day, at this point, we have no real news. I'll say what I've been saying all along, we expect integrity in the process. I think it will come out in a way that makes sense because otherwise, there's going to be a huge disruption and I don't think anybody's interested in that. So the process has been well underway for some time. It's been a very quiet. And at this point, I don't think there's any news. And the timing of it, to me, is totally uncertain. CMS can take as long as they like and until they tell us something, nothing has changed.

Your next question comes from the line of Scott Fidel from Deutsche Bank.

I wonder if you had any preliminary views on how the commercial and national accounts and large group ASO selling season is shaping up for 2012 in terms of any known wins or losses.

Well, for us as a company, our commercial membership is more in the individual, small and mid-sized cases. We have a few large accounts. But we're not a national accounts player like some of the other folks. And so we don't rise and fall on that stuff. We like to focus on more transactional kinds of case sizes, and that's our bread and butter.

Okay. And then just interested in terms of what the 2011 guidance now incorporates in terms of the Medicare operating margin. Clearly, MLR doing better here but you are reinvesting. So assuming you're somewhere north of the 5%, but what specifically is built in at this point?

It's around 6%, Scott. And again, looking at the reinvestment that's again our same procedure and process that we follow every year, to put that money back in, the money over 5%, to put that back into our benefits premiums.

Got it. And then just what's your new view on commercial medical costs trend for the year?

We see secular trend being, right now, in the neighborhood of 5.5% to 6.5%, so let's say 6%. And when we talk about what we thought more normal would be, we would say that would be like 6.5% to 7.5% or let's say 7%. So where we're continuing again to price, as I've mentioned earlier in my remarks, we're continuing to believe and to conduct ourselves in the market as if we're going back to the more normal secular trend.

Your next question comes from the line of John Rex from JPMorgan. John Rex - JP Morgan Chase & Co: So I wanted to do something similar, though, focusing on the Medicare books. I mean, could you talk about how you start this year with an assumption of 5% secular trend. So could you level set us now kind of where you view on -- for your Medicare book is for trend in '11? And then give us the 4 major buckets where trend could be running this year, similar to like we would have done for Commercial for you guys in the past?

Well, we would still see Medicare trend, as Jim mentioned earlier, and I think I want to make sure that everybody goes away with this. We'd still be in the 4% to 5% range that we have traditionally and always said is the basis of all of our assumptions going forward. So we don't see, really, a lot of a change from that. There's been a lot of different discussions in the marketplace even over the last week or so about that. But we haven't seen, really, anything that we haven't talked about since the first of the year that would take us away from that 4% to 5% range. And again, that's sort of the range we've always had in the past. But again, we again, worked hard to improve the 5% operating margin. Those are the things that keep the trend down for us.

Right. And so and I guess what you're saying is that where you still see secular trend that your realized trend would be a period to be running far below that because of the trend vendors that you've put in? So what I was trying to understand is with the trade vendors, where are you seeing your '11 trend running right now. And I then I was particularly interested in getting to the bucket so we can see where you're having the most impact.

Well, we're reluctant to get into the this and thats of the bucket. But I would guess that if we started with a secular trend of around 5%, the trend vendors that we're talking about could improve our trend picture on a net basis by as many as 200 basis points. But again, that's not what we're seeing in terms of secular trend. I want to be very, very careful that people don't think that secular trend is coming down in the Medicare business. It appears like for us and others that 4% and 5% is what the Medicare program runs year after year, and then we do things that we've talked about in the past around 15 percent Solutions that we think that brings our net trend down. And we ultimately then put those into benefits and premiums so that the stability that Mike talked about earlier is maintained. We're really happy to earn a 5% margin in our Medicare book of business.

Maybe one example I can get is, where would your bed days per thousand be running this year through your Medicare book versus a year ago? Kind of up, down, flat in magnitude?

Yes, we're reluctant to get into that level of specificity. We're doing things with nurses, as Mike talked about, with Humana Cares and putting nurses in the field. And those are all paying a nice dividend. But we don't want to get into discussions around what our bed days are, then we're going to go into what our skilled nursing -- nursing facility days are. That would just become a slippery slope.

But you wouldn't -- I mean, you dissuade me from thinking that your trend is running more like 0 right now, your actual trend.

I don't believe it's running 0. It's not running 0.

What we would say is, we've talked a lot about the 15 percent Solution and the 4 components of that, the identification, the HRAs, those types of things. Then working into the guidance for both members and our providers and working it over, again -- and Jim went over this so I'm going to go over it quite fast. Within this, what we do with the providers, the hospitals, the doctors, that's the biggest piece. If you look at the proportions of those, we've already said the identification piece is 1% to 2%; what we do on the clinical things are 3% to 4%; 6% to 7% of the 15 percent Solution comes out of what we do with providers, both the ancillary, the physician and the hospitals; and then there's finally another 1% or 2% that we work on that fraud prevention, making sure that we're not being overcharged and things like that. If you take those proportions of the 15 percent Solution, you'll see that those contribute in the same proportions that they always have.

That would be another way that I would try to characterize it. And I'm the finance guy here, so let me just add. This is one of the reasons we spend a lot of our time focusing on the 5% margin because we have so many moving components that affect behavior of individuals, we have progress in various areas where we're putting in new clinical applications in work that at the end of the day, secular trend runs 4% to 5%, and we target a 5% margin. And those are the 2 key numbers we work with. But actual trend is going to be affected by an awful lot of other things. So it's a little overly simple to try to focus on that beyond what the secular trend is.

Your next question comes from the line of Ana Gupte from Sanford Bernstein. Ana Gupte - Sanford C. Bernstein & Co., Inc.: So back to the SG&A question, what I was wondering was what is baked into your current guidance as far as SG&A ratio for the second half of the year and the full year of 2011. And then going forward, as you contemplate your changing mix of business into the Health and Well-being segment and the breakdown of Retail and employer, as you're phasing down your investments in Star and 15 percent Solution and RightSourceRx and also putting in some SG&A reduction initiatives, how much improvement would you expect to see in the base case, in the bulk case for 2012, and maybe 2013 and that's when things start to really get to a steady state?

Well, I would say that it's difficult to get to a steady state because of a couple of things. One is, for example this year, we're showing and we just raised in this morning's guidance 25 basis points on the operating cost ratio from last year. But when you look at this year against last year, that's actually quite an improvement because last year we didn't own Concentra except the last 15 days of the year, so that's one of the ways that we do reinvestment. Likewise, as we talked about this morning, now we're talking about accelerating different initiatives, and Jim did a very good job of enumerating each one of those things. Those are the things that we sort of reinvest back into. So it keeps the operating ratio in a way that conforms with how we're doing the rest of the business and what the opportunity is to better serve our members and to have ROIs that really help. So it isn't a matter of we get over a core group of spending and then we get to a more normalized lower level in a subsequent year that gives us a better return. Rather, what we do is we try to get rid of everything that's not useful, see what we can do it with those proceeds to, again, increase the ROI. And more to the point, being part of, again, not so much the 15 percent Solution because that's medical, but again, freeing up money and things that help that 15 percent Solution through the spend. Ana Gupte - Sanford C. Bernstein & Co., Inc.: So you don't have in your target and to sort of get the organization behind any reduction initiatives? Do you have a target SG&A ratio of sourcing at 15 percent long-term or some kind of stretch goal that you're working toward?

Well because of what I said, because you're always looking at new reinvestment opportunities, it's very hard to do that. What we like to do is, what I said before, is to show progress on the base of expenses in prior periods so that we can reinvest that money not necessarily lowering the ratio, but also showing that you get better ROIs and more to the point, helps the 15 percent Solution.

That's over complicated. But as we grow and we're feeling very good about our prospects for 2012, that will also create a scale opportunity for us as an organization. So that's another key element of where we see ourselves going forward.

It's never going to fit your models very well, Ana, because as we grow Medicare, we push SG&A down on a percentage basis. As we grow our Health and Well-being businesses, we pull it up. And so the varying success levels against the targets that we have out there in those 2 lines of business will dictate ultimately what that looks for. I will tell you that there's an ongoing permanent effort here to bring SG&A in this company down and get to the right level of spending. And it happens every day, every month and we've had a great run over the last couple of years getting to some pretty serious savings, which will allow us to put some of that money back into other things. So it's a moving target. Ana Gupte - Sanford C. Bernstein & Co., Inc.: Yes, sure enough it's a big hill to get -- whatever 10,000 a year on Medicare. So related to that then -- just segueing into the next question. So there is some disclosure that, that might be as much as 2% provider cuts in Medicare with this enforcement mechanism on the debt ceiling. And I was looking for some perspective on how you see yourself playing that in Medicare Advantage in terms of -- in contracting, would you seek narrow networks and bring your costs down? Or is there a vision where you potentially, in the medium to long term, could even have a better network than Medicare perhaps as the providers start to restrict access to original Medicare. In that way, you can drive your penetration so I was wondering about network breadth versus the cost strategy.

Well, I won't spend much time on the debt thing that's going on because it's, first of all, it's not even final. So but having said that, directionally, I don't think it changes anything one way or the other. We're moving as far and fast and as hard as we can to get the highest level of productivity and value for money across the country, and we're having some pretty good success doing that. And as to the last part of that where doctors might be more interested in participating in Medicare Advantage as opposed to the traditional program, we're actually already seeing that in pockets around the country. I mean, to the extent that physicians get connected to us, start getting good data and getting a better infrastructure and capability to do better for these people at lower costs, they benefit from that. Whether it's our medical home model or whether it's the reassuring relationships we have or any number of other approaches to the relationships with them. And I think there's a really good chance that physicians are going to look forward and say "This is where we need to be because it makes more," than being subject to ongoing fee cuts every couple of years as part of some budget out of Washington which just continues to put pressure on their ability to survive. And so I could point to a number of places around the country where that dynamic is already in play. So that actually bodes well for us. The data assets we have continue to get better and better in terms of understanding which providers are more productive, are more efficient, are hitting our scores, are hitting the things that drive Star metrics. All that capability continues to improve. So I consider the future of our relationship with providers to be very powerful for a number of reasons, and the economics are just one.

The next question comes from the line of David Windley from Jefferies. David Windley - Jefferies & Company, Inc.: So your EPS guidance range -- or guidance raise, excuse me, is about a $0.10 higher than what you estimate in the second quarter. I wondered if that $0.10 -- the upside of that $0.10 is driven by benefit ratio exclusively. Or is there also some membership benefit to that as well?

Generally speaking, it falls out of the benefit ratio that we have increased this morning. In Medicare, we raised it 150 basis points and in the Employer Group, 50. David Windley - Jefferies & Company, Inc.: Okay. Second question then is, on your comments around investing in the Humana Cares program, is it possible to give us some sense of quantification about the cost savings, cost benefit that you can drive in that incremental 25,000 members, perhaps comparing your cost PMPMs to folks that are already in the program?

Well, we said in the beginning that we do a lot of work on return on investments on all of these sort of investments. Obviously, when you take the most fragile first 25,000 or 40,000 or whatever the number is, your ROI's going to be a lot higher because there's a lot more going on with these people. The further we expand this, the lower those returns are going to be. And it's just constantly tight trading the right level of investments versus what we think it'll do for the results. And so we're not ready to get specific, but I can tell you there if there is a point where we wouldn't have that sort of approach to the next 20,000 people, but we're not there yet. And we feel like we get good return for our investment, but also, we're going to have a pretty significant impact on these people's well-being and their health status. So it's a combination of all those things, and we're not there yet. I'm not sure we have a number out there that says we stop at a certain point because we continue to get better at it over time. But there are declining returns the more people you add to it. David Windley - Jefferies & Company, Inc.: Understood. And Mike, what's the cycle time? You get these people in the program, how long does it take before you start to see a meaningful improvement?

Some of it happens pretty quickly. It just kind of depends on their status. I mean, some of these folks have 2 or 3 chronic illnesses and are in significantly different states of wellness. And it's just a question of thinking. We start at the top. We get the sickest ones, then we just work our way down. But it's not long term. Actually, you can have a pretty significant impact with these people pretty quickly by intervening and getting ahead of what's going on with their various chronic illnesses. And so it's relatively quick. David Windley - Jefferies & Company, Inc.: I was hoping to sneak in one more. From the standpoint of share of wallet, your Specialty membership has grown pretty significantly. I wondered if you could comment on some of the drivers.

Sure. The Specialty membership is growing in 2 buckets. First, the individual. We're seeing a lot of nice growth on individual, dental and vision, significant growth there. And then on the group side, we're seeing a nice cross selling of dental, vision and workplace voluntary offerings. We acquired a couple of companies a couple of years ago, and it appears like us being able to put all of our benefit packages together and create a unified solution to employers, it's starting to catch some momentum. So we're pleased about that. Thanks for noticing that.

Your next question comes from the line of Carl McDonald from Citigroup.

I'd be interested in your expectations for the upcoming Star ratings this fall given the timing of when you made investment, and just how long it takes to move some of those metrics. Should anticipate a more modest improvement this fall with really a bigger improvement coming in fall of 2012? Or can things happen a little bit quicker than that?

This is Jim Murray. First, let me say without hesitation that we ultimately want to get 5 stars on every plan that we do business in. And I will say that with the program change that occurs, some of what we are getting paid for now happens in periods where we are just focused on this. We are very good at execution at Humana, and we'll ultimately do significantly better. We think we're going to get some modest improvement this next go-around. But you can see from the level of investment spend that we talked about earlier that this is a real area of focus for us because it can provide additional benefits for the seniors that we serve and that's what we think is the most important thing that we do.

Let me add to that. Let me just level set everyone on this subject, and I'll try to do it as I visit with you, all, over last year or so. Humana is one of the few companies -- well, maybe the only one that has gone nationwide with a full array of product designs. So I would argue these Star awards are best achieved in really tightly well-managed systems. And if you look at our membership and a number of PPO members we have across the country, a whole level that's wonderful because it's a new benefit. And it's a great thing for the seniors and we've been able to manage that quite well. It's a little harder there to get the Star ratings up because you don't have the same sort of tight-knit position environment. We have to do a little more work. I'm with Jim. I think we're going the 5 everywhere. But we don't look like other people when it comes to the makeup of our membership. So therefore, I see this whole Star opportunity as all upside, and I'm happy with the progress we've made so far. And I think we're going to continue to make very good progress here. But we're going to look different than others for a long time because of being national in scale and having multiple product offerings.

And then the Commercial business, be interested if you've seen any uptick in interest from employers, say, 100 to 500 lives in terms of converting from the risk product to the ASO product, relative to what you've seen in prior years.

This is Jim. I don't think that there's a significant uptick. Periodically, people always or companies will always evaluate whether they want to take the risk of going to a self-funded kind of an offering. I don't think we're seeing anything that would suggest that there's a big shift going on in the marketplace.

Your next question comes from the line of Doug Simpson from Morgan Stanley.

I was just wondering. As we're thinking about trends and the comments that have been -- and the commentary in the call this morning, what are some of the better forward trend indicators that we should be looking at as sort of the canary in the coal mine for trend? Just how do we think about that and what is -- what have you learned from previous upturns in the past that may carry over to this time?

This is Jim Murray. I'm assuming you're talking about Commercial trend as opposed to Medicare trend?

Yes, that's fair.

Okay. So what we look through -- look at everyday our base per thousand admissions. We also have a pretty much of an early warning system in terms of pharmacy spend. We get pharmacy spend information on a daily basis, and we can generally see when pharmacy costs are accelerating that it may be a harbinger of an uptick. But again, we haven't seen anything that would suggest that that's occurring as we sit here today.

I'd even go further to say I think that Jim is talking about or giving you indications that it's already begun. So we've got a pretty good radar around what's happening at the moment. It doesn't really help you all that much to tell you what's going to happen 6, 8, 9 months down the road. We remain pretty conservative in terms of how we think about that because that's where people have missed it, is being able to pick it out 6 months from now because we're pricing things today for medical costs 18 months into the future. So I think it's important to remain conservative until we can ultimately determine whether this is a permanent state. I don't think it is, so I think we've got the right approach at this time. But in terms of seeing it when it occurs, we can absolutely do that. But that's not quick enough.

Okay. And then maybe just to switch on the Medicare side, just to confirm the comments earlier around provider reimbursement stability. Is that -- can we assume that with the 2012 bids, you'd be baking in a doc fix into the way you're thinking about underlying trend in that book next year?

That's correct.

Okay. And then any color you could give us on thinking about potentially PDP conversions into MAPD offerings? Just specifically thinking about the Wal-Mart numbers you have this year, what's that opportunity look like heading into 2012?

Obviously, for us, we think it's going to be better because of the growth that we've seen with the Wal-Mart plan. The one thing that I would suggest is that we've also have a Wal-Mart MA offering out there as well, which we think will allow more of a conversion rate than we might have otherwise expected. We, generally -- this past year and the year before, because our PDP membership were shrinking, we were seeing 25 to 30 folks shift from PDP to MA. One of our programs this year will be to have our market point reps specifically speak to some of the Wal-Mart PDP folks to talk to them about the benefits of MA approach and do a needs analysis with those folks. So we expect that we'll see an uptick in that, and that's all baked into some of the growth discussion that we had earlier today.

Okay. That was 25% to 30%?

25,000 to 30,000 members per year this past year and last year. And that's in part because our PDP membership had been shrinking. And now we're happy that we've got an additional 800 to 850 for this year.

There are no further questions at this time. I'll turn the call back over to the presenters.

Let me wrap it up by saying we had a good quarter. We think '11 is going to be very good, and we've guided to that this morning. Directionally for '12, we like where we are from a Medicare perspective as we've shared with you, and we will have more specificity on the third quarter call once we see what everyone has done. I think we see good progression on our clinical integration work and our data analytical work. And so we're very optimistic about where our business is going. And as usual, I'd like to thank all the Humana associates that are on the call today for making these results possible. With that, thank you for joining us.

This concludes today's conference call. You may now disconnect.