Good morning, ladies and gentlemen, and welcome to the Centene Corporation Third Quarter 2018 Earnings Conference Call. All participants will be in listen only mode. Please note, this event is being recorded. At this time, I would like to turn the conference over to Mr. Ed Kroll, Senior Vice President of Finance and Investor Relations.
Please go ahead, sir.
Thank you, Denise, and good morning, everyone. Thank you for joining us on our 2018 Q3 earnings results conference call. Michael Neidorff, Chairman and Chief Executive Officer of Centene and Jeff Schwaneke, Executive Vice President and Chief Financial Officer of Centene will host this morning's call, which can also be accessed through our Web site atcentene.com. A replay will be available shortly after the call's completion also atcentene.com or by dialing 877-344-7529 in the U. S.
And Canada or in other countries by dialing 412-317-0088. The playback code number for both dial ins is 10,123,967. Any remarks that Centene may make about future expectations, plans and prospects constitute forward looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward looking statements as a result of various important factors, including those discussed in Centene's most recently filed Form 10 Q dated today, October 23, 2018, and our Form 10 ks dated February 20, 2018, and other public SEC filings. Centene anticipates that subsequent events and developments will cause its estimates to change.
While the company may elect to update these forward looking statements at some point in the future, we specifically disclaim any obligation to do so. The call will also refer to certain non GAAP measures. A reconciliation of these measures with the most directly comparable GAAP measures can be found in our Q3 2018 press release, which is also available on our website at centene.com under the Investors section. Finally, a reminder that our next Investor Day will be held on Friday, December 14th in New York City. With that, like to turn the call over to our Chairman and CEO, Michael Neidorff.
Michael?
Thank you, Ed. Good morning, everyone, and thank you for joining Centene's 3rd quarter 2018 earnings call. During the course of this call, we will discuss Q3 financial results and provide update on Centene's markets and products. We will also bring you up to date on the integration of Fidelis. Let me begin with Fidelis.
The 3rd quarter was our 1st full quarter with Fidelis operating as our New York State Health Plan. The integration is going very well, progressing as expected. We will further enhance the quality of care and current capabilities of Fidelis as we add case management and clinical programs and incorporate our data analytics tools. We are on track to achieve the synergy and accretion targets. On a run rate basis, we expect Fidelis to add approximately $11,500,000,000 in revenue and over $500,000,000 in adjusted EBITDA including net synergies.
Now on to the 3rd quarter financial results. We are pleased to report another solid quarter marked by significant top and adjusted bottom line growth. It is important to clarify that the operating metrics in the quarter was strong as this may have been obscured by 3 offsetting adjustments booked in the quarter. 2 of the adjustments related to contracts that have expired. These were $140,000,000 benefit related to California IHSS program reconciliation and $110,000,000 charge related to the expiration of our Veterans Affairs contract.
The 3rd adjustment related to a $30,000,000 contribution to our charitable foundation. Membership at quarter end was 14,400,000 recipients. This represents an increase of approximately 2,100,000 beneficiaries over the Q3 of 2017. This growth is in part the result of the acquisition of Pinellas, which closed effective July 1. 3rd quarter revenues increased 36% year over year to $16,200,000,000 The HVR decreased 170 basis points year over year to 86.3%.
This was primarily attributable to the benefit of the IHSS program reconciliation and membership growth in the exchange business. The adjusted SG and A expense ratio increased 110 points year over year to 10%. This was a result of the growth in the exchange business, which operates at a higher SG and A expense ratio and one time costs associated with the expiration of our BA contract. We reported adjusted 3rd quarter diluted earnings per share of $1.79 compared to $1.35 in the same period last year. This represents growth of 33%.
Consistent with our expectations, adjusted net earnings have developed in a quarterly pattern similar to last year. Please note, we reiterate our comments regarding visibility into $69,000,000,000 plus in total revenue for 2019. As is our practice, we will provide full details and updates of 2019 guidance at our December 14 Investor Day. We are still finalizing our annual planning process, but based on reviews to date, the current adjusted earnings per share consensus for 2019 would be within our guidance range. Jeff will provide further financial details, including updated 2018 guidance in his prepared remarks.
A quick comment on medical cost trends. We continue to see as well as anticipate overall stable medical cost trends. This is consistent with our expectation in the low single digits. I would also like to make a comment on pharmaceutical costs and the evolution of the PBM model. There have been some recent media articles regarding this topic and our Ohio Medicaid health plan, Buckeye Community Health.
To clarify, Buckeye is not charging the state more than any other MCO per script. Health plans were paid a flat per member rate and cannot charge the state a penny more even if that member has more prescriptions. As you know, CBS has rescinded their original comment on this matter and there are no duplicate services by CBS and Involve. In fact, Buckeye's per member spend on pharmacy services of $83.79 per month is below the all plan average in Ohio of $87.96 according to the NAIC filings for 2017. We support a shift towards a more transparent PBM model that is sustainable with higher quality and lower costs for consumers.
Our recent investment in RxAdvance is the latest evidence of our approach. As a matter of fact, our first stage will go live with RxAdvance before year end and we have a national rollout for RxAdvance throughout 2019. We look forward to working with the State of Ohio and others to enhance and evolve the PBM model. Moving on to market and product updates. First, we'll discuss Medicaid activity.
Mississippi, in October of 2018, as part of a successful re procurement, we entered into a new agreement to continue to provide services to Medicaid recipients enrolled in the Mississippi Medicaid program. Note that the state added a 3rd vendor as part of the reprocurement process. Arizona, in October of 2018, our Arizona subsidiary Health Net Access began a new contract that integrates physical and behavioral health services through the state's Medicaid program in the Central and South regions. We now have over 100 80,000 integrated lives in this program, representing an increase of 120,000 North Carolina, in early August of 2018, North Carolina released an RFP for the state's first time transition of Medicaid members out of fee for service into managed care. We have been planning for this RFP for several years.
In January of 2017, we established a joint venture with the North Carolina State Medical Society to collaborate on a statewide member focused approach to Medicaid Managed Care. The joint venture Carolina Complete Health was established as a physician led health plan to provide Medicaid managed care services in the state. Carolina Complete Health submitted its RFP responses past Friday. We feel we are well positioned due to our joint venture, which is consistent with our local approach. Furthermore, our participation in North Carolina Marketplace will be recognized in the Medicaid RFP story.
The state expects to announce winners in early February of 2019. Next, Centurion. In August, Centurion announced that the Volusia County, Florida Council voted to award Centurion a contract. Centurion will provide comprehensive healthcare services to an average of 1425 detainees of the county's detention facilities located near Daytona Square. The contract is expected to commence January 1, 2019.
Additionally, Centurion was awarded a contract to provide comprehensive healthcare services to detainees of the Metropolitan Detention Center in Albuquerque, New Mexico. The average detainee population for this service area is 1550. This contract is expected to commence in February of 2019. Note, these 2 recent correctional contract wins offer further evidence that we have gained traction in growing this relatively new product line. Now on to Medicare, we remain focused on building a successful Medicare business.
At quarter end, we served over 417,000 Medicare and MMP beneficiaries. This represents a year over year increase of more than 86,000 recipients or 26%. Consistent with our Medicare growth strategy, we have expanded our geographic footprint and expect to be in 21 states in 2019. The annual enrollment for the 2019 plan year began on October 15. We continue to take a targeted approach to growing our Medicare Advantage business.
In markets that we are focused on, we are pleased with the competitive position of the All World products. Further, we are encouraged by CMS recently released data suggesting we will return to a 4 star MA parent rating for the 2020 plan year. We expect this will have a positive impact on multiple new plans, including the joint venture recently established with Ascension Healthcare. Please note, we expect to have 68% of our MA members excluding Fidelis in 4 star plans in 2020. With Fidelis, it will be 53%.
Next, health insurance marketplaces. At September 30, we served 1,530,000 exchange beneficiaries. This represents a sequential increase of over 26,000 individuals. The addition of Fidelis offsets the sequential loss of members from normal attrition. On a year over year basis, membership grew 49%.
Our exchange businesses continue to perform well in the Q3. We expect 2019 to be another strong year for Ambetter. In addition to expanding our footprint in 6 existing markets next year, Florida, Georgia, Indiana, Kansas, Missouri and Texas, we are in 4 new states Pennsylvania, North Carolina, South Carolina and Tennessee. In 2019, we will be offering exchange products in 20 states. Our strategy remains consistent, focusing on low income subsidized populations.
We do not see a significant change in the competitive dynamics of our markets and pricing appears to be appropriate. I would like to speak to the elimination of the individual mandate in 2019. We do not expect this to have a meaningful impact on the overall performance of our marketplace product. Open enrollment starts November 1. Our guidance includes incremental marketing and other outreach efforts to offset the federal government's continued reduced efforts.
Shifting gears to our rate outlook. We continue to expect a composite Medicaid adjustment of an increase of approximately 1% for 2018. In conclusion, 3rd quarter results offer further evidence of Centene's financial strength and operating capabilities. Centene's pipeline of further growth opportunities remains robust. We continue to explore new growth and diversification prospects, while maintaining our focus on margins.
We are optimistic about our future and the leading role Centene will continue to play in the evolving healthcare industry. As a reminder, our next Investor Day is on December 14 in New York City. We look forward to seeing you there. We thank you for your continued interest in Centene. Jeff will now provide you with further details on our Q3 financial results.
Jeff? Thank you, Michael, and good morning. This morning, we reported strong 3rd quarter results with total revenues $16,200,000,000 an increase of 36% over 2017 and adjusted diluted earnings per share of 1.79 an increase of 33% over last year. Earnings for the quarter were driven by the completion of the Fidelis acquisition and the continued strong performance of the marketplace business. Additionally, the 3rd quarter results include the following items, which in aggregate had no effect on diluted earnings per share.
First, during the Q3, we received cost reconciliation information from the State of California associated with the IHSS program, which ended last year. The information allowed us to estimate the effect of the reconciliation and we recorded a pre tax benefit of $140,000,000 during the quarter. 2nd, the veteran affairs contract expired this quarter. In connection with the conclusion of the contract, we recorded a pre tax charge of $110,000,000 for negotiated settlements and severance costs. Lastly, as an offset to the first two items, we recorded a pre tax charge of $30,000,000 associated with the contribution commitment to the company's charitable foundation to continue to support the communities that we serve.
Let me provide some more details for the quarter. Total revenues grew by approximately $4,300,000,000 year over year, primarily as a result of the acquisition of Fidelis Care, growth in the health insurance marketplace business, expansion in new programs in many of our states, including the Illinois contract expansion and the Pennsylvania LTSS program, other acquisitions, including MHM, CMG and Foundation Care and the return of the health insurer fee in 2018. This growth was partially offset by lower revenues in California associated with the removal of the IHSS program from managed care, which took effect January 2018 and lower membership and revenue in the Medicaid business due to eligibility redeterminations in many of our states as a result of the strengthening economy and lower unemployment. Additionally, the IHSS adjustment this quarter lowered premium revenues by a little over $100,000,000 Moving on to HBR. Our health benefits ratio was 86.3% in the Q3 this year compared to 88% in last year's Q3 and 85.7% in the Q2 of 2018.
The decrease year over year is primarily driven by the benefit of the recognition of the IHSS program reconciliation, which reduced the HBR by approximately 100 basis points. Additionally, the year over year membership growth in the health insurance marketplace business and the reinstatement of the health insurer fee in 2018 also decreased the HBR. These decreases were partially offset by the acquisition of Fidelis, which operates at a higher HBR. Sequentially, the 60 basis point increase in HBR from the Q2 of 2018 is primarily attributable to normal seasonality in the commercial business and the acquisition of Fidelis Care. These increases were partially offset by the IHSS program reconciliation I previously mentioned.
Now on to SG and A. Our adjusted selling, general and administrative expense ratio was 10% in the Q3 this year compared to 8.9% last year and 9.6% in the Q2 of 2018. The year over year increase was primarily due to growth in the health insurance marketplace business, which operates at a higher SG and A expense ratio. The SG and A expense ratio was also negatively impacted by approximately 70 basis points related to the costs associated with the conclusion of our contract with the U. S.
Department of Veterans Affairs and the contribution commitment to our charitable foundation. These increases were partially offset by the acquisition of Fidelis Care. The sequential increase is primarily due to costs associated the VA contract expiration and the charitable contribution previously mentioned. These increases were partially offset by the acquisition of Fidelis Care, which operates at a lower SG and A expense ratio. Additionally, we spent $0.06 per diluted share on business expansion costs during the Q3 compared to $0.12 per diluted share last year.
Investment income was $80,000,000 during the Q3 compared to $51,000,000 last year $65,000,000 last quarter. The increase year over year is due to higher investment balances mainly associated with the Fidelis acquisition as well as higher interest rates on short term investments. Sequentially, investment income increased due to the acquisition of Fidelis. We expect interest income to be lower in the 4th quarter due to lower investable balances associated with the payment of the health insurer fee, risk adjustment and the California rate overpayments mentioned in the Q2. Interest expense was $97,000,000 for the Q3 of 2018 compared to $65,000,000 last year and $80,000,000 for the Q2 of 2018.
The increase year over year was driven by the additional debt to fund the Fidelis acquisition and higher interest rates on our debt associated with our interest rate swaps. The increase sequentially is driven by a full quarter of the senior notes issued to fund the Fidelis acquisition. Our effective tax rate for the Q3 was 33.3% compared to 38.3% in the Q3 of 2017. The lower tax rate was driven by the effective income tax reform in 2018, partially offset by the return of the health insurer fee. Now on to the balance sheet.
Cash investments and restricted deposits totaled $14,300,000,000 at quarter end, including approximately $500,000,000 held by unregulated subsidiaries. Our risk based capital percentage for NAIC filers continues to be in excess of 3 50 percent of the authorized control level. Debt at quarter end was $6,400,000,000 which includes $100,000,000 of borrowings on a revolving credit facility. Our debt to capital ratio was 36.9 percent excluding our non recourse debt compared to 41.2% at the Q3 last year and 36.7% at the Q2 of 2018. We continue to target a debt to capital ratio in the mid to upper 30 percent range.
Our medical claims liability totaled $7,000,000,000 at quarter end and represents 51 days in claims payable compared to 44 days for the Q2 of 2018. The increase in DCP is a result of the addition of the Fidelis business, which accounts for 4 days timing of claims payments and business expansions, which accounts for 2 days and the impact of the IHSS program reconciliation for one day. Several of the items influencing the DCP increase this quarter are timing related and are expected to reverse. We expect the DCP to be in the mid-forty range on a run rate basis with the inclusion of Fidelis. Cash flow provided by operations was $548,000,000 in the 3rd quarter.
Cash flow was positively impacted by approximately $350,000,000 due to the timing of Fidelis Care claims payments and $175,000,000 due to increases in experience rebate payables, primarily related to the performance of the health insurance marketplace business and the previously mentioned IHSS program reconciliation. Before we discuss the changes to our 2018 annual guidance, let me spend a few minutes to update you on the Fidelis acquisition and the effect on the Q3 2018 results. On July 1, 2018, we acquired substantially all the assets of Fidelis Care for approximately $3,500,000,000 in cash consideration, net of the preliminary working capital adjustment. The integration is in process and we expect to achieve the previously communicated synergy targets. In connection with the completion of the acquisition, during the Q3, we incurred approximately $401,000,000 or $1.46 per diluted share of transaction costs, including investment banking fees, legal costs and $324,000,000 representing the present value of the contribution to the State of New York as part of the undertakings associated with regulatory approval.
Now on to our annual guidance. We have increased our 2018 annual adjusted diluted earnings per share by $0.02 at the midpoint to reflect the performance in the 3rd quarter and narrowed the ranges of several other guidance metrics. In summary, our updated full year 2018 guidance is as follows: total revenues of $59,800,000,000 to 60,300,000,000 dollars GAAP diluted earnings per share of $4.34 to 4.50 dollars adjusted diluted earnings per share of $6.90 to 7 point
$10 an HBR of
85.9 percent to 86.3 percent SG and A ratio of 10.5 percent to 10.9 percent adjusted SG and A ratio of 9.7% to 10.1% and effective tax rate of 34% to 36% and diluted shares outstanding of 199.8 to 198.8 to 199.8000000 shares. Additionally, we are increasing our full year 2018 business expansion costs from $0.28 to $0.32 per diluted share to $0.30 to $0.34 per diluted share. In summary, we were pleased with the strong performance in the Q3 and the completion of the Fidelis acquisition that we expect to continue to drive long term growth and margin expansion. That concludes my remarks. And operator, you may now open the line for questions.
Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session.
Exchanges and how you thought about 2019. I guess you mentioned that the competitive landscape hasn't really changed that much, but it does seem like that there's a number of counties that last year only had one option and this year, at least have 2. And you guys often stepped in there to be that one option. I wanted I think initially the market was concerned that being the only one there was going to be a bad thing. You guys have really outperformed.
Wondering now whether there's potential risk on the other side. If a new competitor comes in, does that potentially change the risk pool for you in that market?
Let me respond to that Kevin. I don't see a change in the risk pool. We have had the last 2, 3 years 80% reenrollment of our membership. So we expect that to continue. There's a great deal of satisfaction with it.
And we continue to focus on the subsidized market and some of the others are coming in at higher levels than that. So I don't really see any material changes within the marketplace.
Okay. And then I guess just a question on the MA side. It looks like you guys expect now to have the parent rating back for 2020. How did you think about the 2019 pricing for STARZ, particularly on some of the new contracts. You have this issue where you fell off on the star ratings for 2019, but you expect it to show improvement going forward.
Did you kind of think about it in price to the actual star rating that you had in 2019? Or did you kind of take a longer term view that it's better to grow the business and we may see some margin impact in 2019, but then getting back?
Well, I'm going to ask Kevin to join in, but I last year said we are committed to growing the business. So, but I'll let Kevin pick that up.
Yes. Hi, Kevin. I just would reinstate what Michael had said. Our position has been to take the longer term view. I think when you look at both our expansion strategies, the states we focused on, the potential Ascension Alliance, I think it all reflects that.
Okay, great. Thank you.
The next question will be from Josh Raskin of Nephron Research. Please go ahead.
Hi, thanks. Good morning, guys.
Good morning, Josh. Jim.
Good morning, Michael. First question just on the exchanges and sort of just how you guys think about the bidding 'nineteen, is there a reset to your bid margin or do you think sort of 'nineteen, is there a reset to your bid margin or do you think sort of where you are sustainable? And again, you've been sort of a sole operator in a lot of counties. So my guess is there's no need to make major revisions there. But just how are you thinking about long term margins?
And is there any reset we should expect for 2019?
I'll let Jeff answer some others comment. But as I said in my previous answer, we see our position in the marketplace not changing, but relative to the please Jeff, something
you'd like. Yes, yes, not to get into too much details about 2019, but we are certainly not planning for a margin reset in 2019. That's certainly not our view.
Okay, that's perfect. And then just on North Carolina, they released the set of bidders. I was actually a little surprised there were only 8 plans that were listed. Big contract, so there's risk? Or is it, nope, it's just such a large contract that there's only a few plans that could realistically win this?
I guess I'm just curious on your perspective from the competitive landscape in North Carolina?
Yes. Hi, it's Kevin. I think one potential factor contributing factor to what you've just said is that the as you probably know is that it was a complicated bid. And when one looks at the requirements on an MCO, the respect to care management requirements, network and such, the mix between how provider organizations would be implemented as well as outside MCOs, it was it is a complicated bid. So again, we're very excited about our bid.
We believe we have a strong one, but that may be a contributing factor.
Yes. I'll just add to it. I think when you look at the scale, the size, the expectations, the technology required to do it, a lot of people initially get excited about sit back and say, I think maybe I may have to sit this one out. And so we're comfortable with our position, our partnership and think and expect to do well with it.
Okay. And just to clarify, there was nothing in the bid or the RFP that came out that changed your view on the ability to earn a reasonable return, nothing around rates or continuity of care, anything like that, that's going to make it onerous in the early periods?
No, I don't think so. I think you always look at how bifurcated is, how many member how many plans they have in a particular region. But I think when you look at it in total, I think it's going to be fine. You always have your 1st year where you're educating people and we have planned for that accordingly. We've always said new plans, you want to go through 3, 4 quarters.
So that same matrix applies and we're planning accordingly.
Perfect. All right. Thanks guys.
The next question will be from Steven Valiquette of Barclays. Please go ahead.
Thanks. Good morning, everybody.
Good morning.
So just quickly for the California IHSS payment. I think you guys mentioned this at your Analyst Meeting back in June. So it seems like it was included in guidance. But just to clarify, is that $140,000,000 is it still subject to any material adjustments depending on minimum MLR calculations in California for those prior periods? And also are these California risk corridors, are they all finalized now?
Just want to get more clarity around all that. Thanks.
Yes, a couple of things. This was not in guidance. So it's never been in guidance. But the real issue here is they're reconciling the program from the beginning, its inception all the way back to 2014. And this is really the Q1 that we had cost and I would say member eligibility information from the state in order to perform the reconciliation.
So the state has the data, not the MCO. So obviously, this is the first time we had a look at it. It is not done. I think in the press release, you'll find that it says that we expect the 2014 through 2016 information to potentially get reconciled late this year or early next year. And then there's still the 2017 year, which would come later, maybe in 2019.
So what I will tell you is that it could get adjusted and if it does we would disclose it accordingly.
As far as the breakdown of $140,000,000 how much of it relates to 2014 to 2016 versus 2017? Is there any just rough breakdown of it that way just to help us get a sense of the magnitude for how much it could be adjusted?
I think there were rate changes in the program in the later years. So I think a significant piece of that relates to 2014, 2015 time periods with a little bit less in 2017. So I would say it probably starts larger at the beginning and gets smaller as the years go on.
Okay. All right. That's helpful. Thanks.
The next question will be from Ralph Giacobbe of Citi. Please go ahead.
Thanks. Good morning. Good morning. Obviously, a lot of moving parts in MLR and SG and A. Any reason why you wouldn't exclude some of those sort of one time items from the adjusted figures?
Well, we've never historically done a, if you will, an adjusted HBR and adjusted SG and A ratio. So but I think our preference in general is to disclose, and not having an adjustment section that's very long in the filing. I think that makes it confusing. And so I think our view was this was a much more easier way to just disclose the information.
I just want to add to that. I think what's really important as we change lenses to a $60,000,000,000 company versus what a lot of people remember us as historically. You're going to have a lot of adjustments that come through in a given quarter. That's just the nature of the business. And what we did this time, we wanted to ensure that we had the offsets and to ensure that there was no income taken into it, we took the $30,000,000 and put it in the foundation because we wanted to really even it out.
And so I agree with Jeff, obviously, we decided to keep the adjustment simple, so people understand it. And we believe that most people when we say here's a one time change one way or the other, tend to discount. I'm used to an environment where they say, that's to be expected in a business this size. At any given quarter, any given time, there's going to be adjustments that are good and bad, but you have to treat them just as one time events and not part of the ongoing. What I'm pleased with in this quarter is the ongoing business is performing well and consistent with our expectations.
Okay.
All right. Fair enough. And then
just a follow-up. The administration was out yesterday with sort of more flexibility to states around waivers and the like. Any initial thoughts around that and maybe implications to that, whether it's even a consideration for 2019 as opposed to maybe 2020? Thanks.
Kevin? Yes. It's a good question. I just finished reading the guidance last night. Clearly, I think we support the ability for states to have additional flexibility.
I think it plays well into our both our business model and also our strategy. With respect to some of the nuances in the guidance, I think we're all still studying that.
Okay. Thank you.
The next question will be from Steve Tanal of Goldman Sachs. Please go ahead.
Good morning, guys. Thanks for the question.
Good morning, Steve.
I wanted to just follow-up on a couple of the ratios, specifically first the HBR. At 87.3, I mean just looking at typical and that's kind of ex the IHSS item, the typical seasonality and thinking through kind of the impact of Fidelis, really trying to understand, I guess the question would be what was the impact of Fidelis if you could spike that out, because I think this HBR looked pretty decent exit?
Yes. I want to comment, but as we go forward, we've always had the policy. We look at a consolidated basis versus bifurcating it, because it gets too confusing next quarter, what about this or that. So we want to look at it in totality, but you can give me some kind of directional.
Yes, yes, I think you're exactly right. Obviously, you have two things. One has been here the whole year, the HIF, right? The health insurer fee pulls down the HBR. If you're comparing to last year, right, because last year there was no health insurer fee.
And then you have the IHSS adjustment. So those 2, I would kind of put in a separate category. And then you're correct, you do have an increase for the Fidelis business because it does run a higher HBR and that was predominantly offset by the marketplace because a lot of the growth organic growth this year has been in the marketplace business. So the increased volume of that business
those. And I guess just on the SG and A side, came in a bit higher than we were thinking. And I guess one thing that I heard on the call so far was just the increased business expansion costs and that's I guess stepped up about $0.02 or so. Was that in the Q3 or is that to come in the Q4? And just step back on that like should we think about that 0.3 dollars number as kind of a run rate number at this point?
Some of that is in the Q3 related to our as Michael mentioned in his script related to the open enrollment period. And so what you have to remember is, in order what we do is the business expansion costs are incremental, so incremental to the prior year when you look at, for example, the marketplace business. So, I would say it's a pretty good run rate, but it can be lumpy from time to time depending on Medicaid RFPs, right, because a lot of times, for example, if we had a oneone start date, we would have a lot of startup costs in the Q4 for that. So I would say it's a pretty good run rate. I think that's where we've been in that range for the last several years.
But obviously, depending on the timing of awards and how many awards are in a specific year, it could change.
Got it. Okay. Thank you.
Thank you.
The next question will be from Sarah James of Piper Jaffray. Please go ahead.
Thank you. I was hoping that you could walk us through capital deployment priorities. As you think about the business model going forward, are there certain areas that would make sense for Centene to add assets or expand their exposure?
Yes. I mean, I think, obviously, you've seen a lot of the capital that we continue to deploy and have deployed over a long period of time is really related to growth and adding capabilities. And I think you've seen some of that this year with the addition of CMG, our investment in RxAdvance, INTERPRETA. So we've continued to add capabilities to the business as well as grow the business. So every new market requires statutory capital, that's capital deployment, increasing the marketplace growth in that business.
So I think it's a consistent strategy going forward. We're looking for ways to add capabilities that in the long term will continue to grow the business successfully.
Okay. And can you talk about the rate outlook in a little bit more detail? So you mentioned reiterating the 1% for 2018, but we've had a couple of updates recently that would put that were higher than that. So I'm just wondering as you're looking for the rest of 2018 focusing 4Q or kind of rolling out of the year, are you still thinking that 1% is accurate for 4Q or could the recent update provide some upside to that?
Yes, yes. Just to I think we've been and I may get this a little bit off, but I think we've been close to 1% for the last 3 years. And just to give you the idea about what we're giving you as far as what the 1% is, it's the annualized effect of rate adjustments in this year. So it's not just as they occur, it's the annualized effect of those. And the other thing is that it's a net rate adjustment, meaning if the state changes the fee schedule and provides a premium adjustment for that, we've excluded those.
We've netted those together because typically, one percent. We've been in the 1% range for the last several years and I think I wouldn't see anything different going forward at this point in time.
And I think what is important there is what Jeff said there, the easiest thing we got a 5% increase or something, but if they raised other fees comparable to that, then that's a mislead. So I think we want in the interest of clarity, report the net number.
Great. Thank you. The next question will be from Matt Korsch of BMO Capital Markets. Please go ahead.
Hi, good morning. Thank you.
Good morning, Derek.
Could I just ask about the tax rate? The rate looked quite low in this quarter and I think you're maintaining your tax rate guidance for the full year. Is that implying something pretty high for the Q4? I'm just wondering if you can talk to what's going on there. And apologies if I missed something you already said.
Yes, yes. No, Matt, that's a good question. I think, what's driving the tax rate obviously for the quarter is the significance of the adjustments related to the closing of the it's really the transaction costs associated with the Fidelis transaction. Those are deductible at a statutory tax rate that's roughly around 24%. So we've known about these costs for some time and our guidance has always included those.
So again, that's why you didn't see a revision to the tax rate range. As for the full year, we on a GAAP basis, we're going to get back to in between our guidance ranges that we've provided today.
Okay. Okay. Okay. Got it.
Yes. So that's also, Matt, a good example of what I said earlier terms of in any given quarter, you can have a particular effect that impacts.
Yes. Just to give you a little more detail, Matt, we've always had, I would say, a lower back half tax rate because of the addition of Fidelis, because Fidelis is not subject to the health insurer fee this year.
Right.
And so their tax rate is much, much lower.
Right.
Got it. Yes, but for the full year, we're comfortable with our guidance range.
Got it. And could I just ask a question on if you look at the organic growth going into 2019 and above 69,000,000,000 dollars Am I correct that implies a high single digit range for organic growth if you sort of broadside of the barn adjust out for Fidelis?
I think once again for consistency, we've always when there's a partial year on something, we've always had to adjust for the next year. So, if you go year over year, that's consistent. We look for consistency in how we do this. But anyway you look at it, I mean, it's a lot of significant growth for that. And then that reflects what the visibility we had last June.
And we'll update it in more detail and give you more detail in December.
Okay. Okay. Thank you.
The next question will be from Peter Costa of Wells Fargo Securities. Please go ahead. Mr. Costa, your line is open. You may be muted on your side.
Hi, good morning. Sorry about that. Good morning. Was there
any of the guidance change or the metrics changing due to the performance at Fidelis being different than you expected? And what things have you seen at Fidelis that's been different from your expectations either positive or negative?
I think it's been very consistent with our expectations and the reaffirmation of the revenue and the EBITDA, I think reflects that. It's a well run company and we're very pleased with it. I mean, we were able to back out you talk about integration, day 1, they were on our general ledger. So, I mean, this is a company that had to act together and it's everything we could have expected.
And just as a follow-up,
why was Fidelis's care view of the individual mandate going away, which caused them to initially seek much higher rates in the exchange business, so different from your view of the individual mandate going away? Is New York somehow different? And are you seeing what initially saw now that you're seeing what's going on in New York?
Okay.
So you're right, New York is different. New York has a basic health plan, which I think you're probably aware of. It's one of 2 states that in Minnesota that have that. So just by definition, they're going to have different underwriting issues and risk management issues and selection issues than states without that, the BHP.
So that's what caused them to seek these much higher rates in New York than you were seeking rate increases for next year?
Yes. If you're a state with a basic health plan like those 2, there are definitely different underwriting issues that one has versus a state without that.
Okay. Thank
you. And we, of course, could not get involved in any discussions on their rate adjustments until after closing. That would have been inappropriate.
Understood.
The next question will be from Michael Newshel of Evercore ISI. Please go ahead.
So looking at the RFP pipeline, is there any update on expected timing of the Star Chip and Star Plus contracts in Texas after the cancellation repost of the RFP a few weeks ago?
I think you see it's a moving it's a movable piece, but Chris, what's the best
I'll give you my best shot, Michael. Right now, it looks like the as you know, both of the RFPs have been reissued and are due in mid November. We expect that the awards are going to come Q2, Q3 of 2019. And right now, the projected start dates for both of these are Star Plus will be sixone of 2020 and the Chip and Star RFP will be nineone of 2020.
Okay, great. And how about and also what's the latest on Pennsylvania, whether the HealthChoices contract will go through another bidding process, the courts vacated that?
I haven't heard anything. I mean, it's been very silent. And we'll continue to focus on long care doing a great job there. The East, getting ready to bring that up and that's going well. But I've decided not something that I'm just going to wait for him to call and say it's time to try a 3rd time.
And we've done well twice, so we'll see what happens this time.
Got it. And the existing numbers will just continue in the meantime?
Yes, I'm sure. I mean, that's there's no I mean, they need the help, they wanted and whether it's a you have an election coming up, the new governor will be in place potentially, we'll see what happens there. And I'm not forecasting the election, so Ms. Regis, but so there's a lot of variables. So we have so much going on now that if they want to wait a little bit, that's okay.
We have a full place.
Thank you.
The next question will be from Lance Wilkes of Sanford Bernstein. Please go ahead.
Yes, good morning. Good morning. Just a quick question on the days claims payable and the timing issue, more predominantly on the non Fidelis. Was that related to any particular products? Or if you could just give a little more color on that, that'd be helpful.
Yes. No, nothing specific. I mean, when you look at the days in claims payable, some of this depends on which day of the month the actual quarter ends on and when our check runs are scheduled. Obviously, we're fairly large, so we're making a lot of payments every single day. So it just depends on that.
That's what most of the timing items are related to. And I think I was pretty clear in my script that long term we think in the mid-40s is a good proxy for where we're going to be with the addition of Fidelis.
Okay. And then on RxAdvance, so you made additional investment in convertible preferred and you talked a little bit about the rollout in 2019. If you could talk a little more about both how you're thinking about rolling out that capability, how it replaces existing capabilities and what would be the impact to a state's kind of pricing model as a result of this? Is it, do you frequently have like separate capitation rates related to pharmacy and this is going to transfer it to more transparent pricing or maybe just some more color around that?
Yes. What I'm going to do is Jesse has been leading that as someone asked him to bring us up to speed on it.
Yes, it's good combination of questions there related to RxAdvance. So I think as Michael referenced in his comments, I think the important starting point here is that we're really investing in the future kind of more transparent version of the PBM model. So that includes making investments in the technology platform, which is really where RxAdvance is today. So we're rolling that out on a market by market basis as we referenced that rollout, has been in process since the initial investments and will initiate in the end of 2018 and continue to occur market by market through 2019. In conjunction with those new implementation of the platform, we will be moving to a different operating model, which is built around transparency and more focused on cost sharing for total cost of care.
So integration of pharmacy costs with the more comprehensive total medical cost. And we do believe that over time delivering those services more efficiently will provide both higher quality and lower cost for all of our customers, including states.
That is going to be a game changer.
Got you. Okay. Thanks so much.
The next question will be from Dave Windley of Jefferies. Please go ahead.
Hi, thanks for taking my question. It looked to us that you added something like 110 counties in Medicare Advantage for 2019. You've got the Ascension JV, the stars that were discussed earlier in the call. Michael, I'm just interested in your kind of longer term view aspiration for Medicare Advantage and the business mix for Centene?
Yes. I think I've said that when we talk about our growth that I view the Medicare Advantage product as continuing to fuel our growth into the next decade. And we've been using last year, a little bit of this year as the learning process and gradually expanding. And I keep telling you it's not how fast, it's how well, get the fundamentals right. And that's what we're doing.
But I see it as a very important part of what we're doing and you'll continue to see it. And we've built systems capability for it. And I think that's also very important, whether it be the RxAdvance, the interpreter, things that help improve outcomes. So we see it as a very important part going forward.
Thank you. And then at the top of the call, you talked about Fidelis and the adding of case management and clinical programs and things like that. I think you've been fairly transparent about targeting their HBR as your synergy target. How quickly can those things happen? And do you think the benefits of those things are fully captured in the synergy targets that you've laid out or can those be exceeded over time?
Well, I think, one, we'll be implementing them as we speak. And it's something that we've got ready for during the extended period before we could close. So those are the kinds of things we could talk about and did. So I think it will. And we're very careful from the standpoint of GAAP reporting and how we do things that from a conservative standpoint has to be consistent with appropriate GAAP accounting.
I would always hope that we can under promise and over deliver a little bit. And so we want to keep the expectations real and the timing real, but we're very hopeful on the benefits of all this as they are. And I know they were looking forward to our systems and that capability. So there's things we're learning from them. So it's really great to put 2 big companies together like that.
Okay, great. Thank you for that.
The next question will be from Zack Sopcak of Morgan Stanley. Please go ahead.
Hey, good morning. Good morning. Thanks for the question. I wanted to ask first about just your turnaround in MA STARZ. And from your perspective, what really drove the improvement and were there any incremental investments involved to get you up for 2020?
Well, I will ask Kevin as well as jump in. But I think that's something that's a priority and we've been focusing on it and we're not satisfied with where we are. We're going to keep pushing it to increase it and make it better. And that's just when it happened, we got involved with it. We made it a priority to make the investments to get there.
And then we caught a few breaks along the way as well. So, Kevin, you want to take that?
I think Michael said it. It is clearly a priority. Michael has made it pretty clear to us what his expectations are. We've got a strong team that's focusing on Starz as well as RA and other quality activities. So it's about execution.
Great. Thank you. And then just to clarify on your charitable contribution. So if I look back at your 2017 and 2016 numbers, you excluded them from adjusted net earnings and but now you are including it in adjusted net earnings. Going forward, should I just consider your charitable contribution to be included into it in adjusted net earnings?
Yes. I think this goes back to what similarly to what we did this quarter.
Okay, great. Thanks guys.
The next question will be from Justin Lake of Wolfe Research. Please go ahead.
Thanks. Good morning.
Good morning.
Just wanted
to come back on the tax rate. First of all, is there you're saying that the one time costs from Fidelis were deductible in the adjusted number?
Well, no, they're deductible on your tax return, right? They're deductible on your tax return at their effectively their statutory rate, which is around 23 and change, I guess is what I would say. So, I mean, those are actual costs that we burden that when we file our tax return, we'll take a deduction form.
Right. But you so, I guess what I'm just a little bit confused by, if I'm understanding this correctly, is you one time the cost of the Fidelis integration, right? Those are not included in the adjusted?
In the adjusted earnings, right. That's exactly right. So we had the costs that we're effectively backing those out at the applicable tax rate at which they will be on our federal tax return.
Right. Did you also one time the tax benefit or the tax shield? Or are you saying you ran
Yes, yes, yes. If you look at the press release, the tax it's actually they're combined. The tax benefit of those deductions is disclosed in the press release, but it's aggregated into one line, right?
Right, so
Yes, it's the 65 it's the amortization and the transaction cost, the tax benefit of both of those are aggregated into one line in the press release. I think it was $110,000,000 I think for the quarter, right?
Okay. So the adjusted tax rate, right, when you look at adjusted pretax income and then adjusted after tax income and look at the tax rate, that tax rate doesn't see the benefit. It just looked somewhat low, lower than expected. And it kind of implies the Q4 is going to be pretty meaningful given you didn't change the guidance.
So Well, I think this is
a little bit confused.
Yes, yes. It's the magnitude to some extent because GAAP net earnings were so low. But I mean, we're guiding to a GAAP number, right? So if you look at the GAAP number for the quarter is roughly 33%. I know it has a small amount of earnings because of the significance of the adjustment, right, of the transaction costs.
But we're guiding to a GAAP range, which is that's why we didn't actually change the range because we're going to get to that GAAP range. So recalculate your math on the GAAP financial statements and that will give you what you're looking for.
Got it. So maybe if I could just follow-up the adjusted tax rate we should be thinking about for the year? Maybe that's the only way to think about it?
Well, we don't really give an adjusted tax rate, right? I mean, what I can tell you is those items specifically on the tax return are deductible at a statutory rate, which by the way the difference between the statutory rate and the rate that you see on our financials is has a large piece of it associated with the health insurer fee. The non deductibility of the health insurer, yes. So that is playing into the calculation, which is why the math is challenging to understand the way you're trying to do it.
All right. Well, I'll take a harder look. I know there's a lot of moving parts in the quarter. And then just lastly on the services business.
Yes.
When I look back at the Q3 last year, obviously, it looked like a better a pretty kind of a strong margin in the quarter on the services business in 3Q 2017. Obviously, it looks like it's normalizing more than anything maybe in Q3 'eighteen. Is there a way to think about this services margin as we go forward? Is this a good kind of run rate, this kind of low 80s kind of cost of services?
Yes, I think I'll just give you a couple of pieces here, Justin. I think the services line continues to change specifically with some of the deals that we've done last year. But the services margin that you see in the financials, it would have been a little bit lower because of the VA adjustments that we took this quarter. So if you exclude those, it would have been lower and more consistent with last year. And that's because the 3rd quarter has a lower cost of services ratio because that's typically when we get the information on the USMM ACO programs and we have the reconciliation and that The wind down of the VA program that was not work was at full speed until September 30 that wound down throughout the quarter.
And then these VA adjustments that we mentioned also inflated the cost of service ratio a little bit. So I would say the mix in that line continues to change, but I would say mid to low 80s is probably a good estimate. And that could fluctuate by quarter depending on when we have reconciliations in a lot of these programs.
Thanks. Appreciate it.
The next question will be from Ana Gupte of Leerink Partners. Please go ahead.
Hey, thanks for taking the question. A couple of questions. The first one was, as you think about your margins going forward, do you see any reason you couldn't expand margins, your mix shifting to exchanges and MA? Looks like trend is weak, you have a better star rating starting 2020 investment income could go up with interest rates. So what would your normalized margin
interest in expanding margins. I think that's appropriate and the scale, the size, the activities we have going, the technology we're applying to improve medical costs over time, all will tend to give us the ability to expand margins and we can get more specific in our December call.
Okay, great. Thanks. Thanks for that. That's what I would have thought. The second was on exchanges for 2019.
What are you expecting given the returns are you all making? And is your growth likely to come from secular growth? Or are you thinking of it more from just your geographic expansions and share shifting within your existing markets or a bit of both?
Well, I'm going to ask you to kind of stick with us in terms of not getting too granular on '19 until December. That's a pattern we've as well established over a lot of years. I will say that from the standpoint our focus continues to be on the supplements and that portion that has the premium supplement and we see that continuing going into 2019. So it's going to be business as usual for us and we're comfortable with the attrition we had this year relative to previous years, the reenrollment we had, everything says it's very much business as usual. And I thought I think you heard Jeff comment earlier that from a margin standpoint of business we see maintaining that.
So it's a business we understand and we've developed systems to continue to build it and maintain it.
Okay, great. Thanks. One final one, any update at all on the Texas RFP? I believe the
Well, I think, Chris, you just gave a little detail. You want to repeat that.
Sure. I'd be happy to, Michael. Both of the RFPs that were canceled have been reissued and are due in mid November. The awards will be announced, we believe, in Q2 and Q3 of 2019. Projected start dates for Star Plus will be 61 of 2020 and Chip and Star RFP our start date will be 9one of 2020.
Very helpful. Thanks for the questions.
Thank you.
The next question will be from Gary Taylor of JPMorgan. Please go ahead.
Hi, good morning. Just a couple of questions. And just sorry to go back to the tax rate again. I think there's a perception that the quarter did benefit materially from a lower tax rate. And I followed your discussion, but nondeductibility of the HIF actually serves to increase the effective tax rate, right?
So 8 over 24 on a GAAP basis is 33, but including non deductibility of the HIF, 8 over like a 202 number, it's like a 4% number. So it does look like there was a tax benefit in the quarter different from what you've seen in the first half. And Fidelis would just be a few 100 basis points, I think. So, do you follow where I'm going and where am I wrong on looking at that? Yes.
I mean, I can understand your I can understand where you're coming from. I guess what I would say is this is nothing different than what we've already had in our guidance from when we had these costs associated with the Fidelis transaction. So yes, so Fidelis lower tax rate, not subject to the health insurer fee. You're pulling 1 item or 2 items, putting them down below the line and you're pulling them out at a statutory rate versus your annual effective rate, which includes the non deductibility of the health insurer fee. So I think it's more complicated than that, but we certainly don't view that there was any tax benefit in the quarter.
This has been our guidance for we're guiding to an adjusted number on a full year basis and we don't see any tax benefit to the quarter the way we've seen it since these costs associated with the regulatory undertakings were known. Sure. Maybe another way, just to sort of look at the quarter, if we look at pretax earnings were up $262,000,000 in the Q1, dollars 89,000,000 in the second quarter, adjusted pretax earnings up about $110,000,000 this quarter. But Fidelis, if it ran a 4% margin, would have been over $100,000,000 of that. So it does look like the pre tax earnings growth from the rest of Centene slowed this quarter.
Is that something that you'd acknowledge? Does that make sense? So you're adding back the which pieces are you adding back, the merger costs and the amortization or just the merger costs or? Yes, both. It looks like the adjusted pretax would be $490,000,000 which is up like $110,000,000 versus the prior year, which I think was the piece you may be missing is the exchange business and how the profitability of the exchange business works, right?
Remember it makes yes, it makes a lot and the other thing is that remember the enrollment dates were accelerated this year. So the Exchange profile is actually a lot different and it's a more meaningful piece of the business. That's bigger. That makes some sense. Last question, The specialty operating income was a $51,000,000 loss.
It was $102,000,000 year over year. You called out the VA termination costs as the major factor there, but it still would have been about $40,000,000 of OI versus 100 $2,000,000 And you said other federal contracts and then some carve in of behavioral. Is there any more color you could tell us on just the specialty operating income and where there might be some margin pressure? Yes. Actually, I think some of this is related to the integration of the physical and behavioral health.
So some of those behavioral health revenues and margin is now embedded within our health plans because we've moved to an integrated approach. Okay. Thank you.
The next question will be from A. J. Rice of Credit Suisse. Please go ahead.
J. Rice:]
Hi, everybody. First of all, maybe a numbers question and one other broader question. In the MLR, when you ex out for the unusual items, you're up you've improved 70 basis points year to year. And I think in the prepared remarks, you said a lot of that was due to the HIF and the health insurance exchanges. I just wondered, I mean, it seems like you have maybe I'm wrong, but 4 major things, your core Medicaid, your Fidelis, your Hicks and then the health impact.
Any way to sort of parse out where you're seeing improvement year to year in MBR and where there's if there is any place where there's pressure?
Yes. I mean, I think those are the items that we mentioned. I mean, as we look at the business, I think the Medicaid business was pretty consistent. That's why we didn't highlight it as a driver of the HBR metrics. That's why we highlighted obviously Fidelis coming in would be an increase to the HBR and the marketplace, the size of the business is a decrease on a year over year basis.
So we highlighted kind of the what I would call the drivers for the quarter.
And your Year over year,
year over year, by the way, just making sure.
Yes. Your HICS HPR, was it significantly better this year than last year?
No. I think it was in line with our expectations. I think it's volume the magnitude of the business, obviously, it's a lot larger.
Right. Okay. So it's mainly just the growth as opposed to the absolute ratio?
Yes. Yes, it's the growth on the business.
Okay. And then my bigger picture question is obviously with Fidelis now done, your balance sheet still sort of within the range that you guys historically have targeted, I would say. And acquisitions have been a big part of the growth story for the last couple of years, even bigger acquisitions. What's the appetite of the company to look at additional deals? Do you need some time where you're settling in with Fidelis?
Or you've done a couple of big ones in pretty rapid succession? Are you open to other things?
Well, I think Fidelis, the integration is well there. I
mean, I'll
put it in this context. We know that the closing got delayed, which gave us a lot of time to prepare for a very effective integration. So it is where it needs to be and it's appropriate. So if an opportunity came along, there is no reason for us not to do it. We have a strong balance sheet.
We have a lot of capability and we are in a position to do it. But it has to be the right time, the right place and be 1st financially effective and then strategically. Would it
be reasonable to think that Medicare, given your focus on growing that, is a primary place to look? Or are there other areas have?
Well, I think I mean, look, we're looking very broadly. I mean, you've seen us with the focus on technology and there's some really effective technology that's going to be providing a lot of significant dividends and already are. We had our technology committee meeting yesterday demonstrated that we're moving more and more to a leadership position there. So there's a lot of very good opportunities there that stay tuned.
Okay. Thanks a lot.
And ladies and gentlemen, that will conclude our question and answer session. I would like to hand the conference back over to Mr. Nador for his closing remarks.
Well, I want to thank you for all your questions. I hope it clarified some of the outstanding issues because we I believe we had a strong quarter and the matrix were right. And what people refer to as noise and puts and takes, that's normal cost of business in a company outside And what's important to us is that the fundamentals are strong. It's headed the right way. And we're looking forward to the Q4 and we're looking forward to the December.
We can tell you how strong 2019 is going to be. So we thank you very much for your time, attention and great questions. Have a good day.
Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. At this time, you may disconnect.