Good day, everyone, and welcome to the Centene Corporation 2018 Second Quarter Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. And please note that today's event is being recorded. I would now like to turn the conference over to Ed Cole, Senior Vice President of Finance and Investor Relations.
Please go ahead.
Thank you, William. Thank you, William, and good morning, everyone. Thank you for joining us on our 2018 Q2 earnings results conference call. Michael Neidorff, Chairman and Chief Executive Officer and Jeff Schweneke, Executive Vice President and Chief Financial Officer of Centene will host this morning's call, which can also be accessed through our website 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 for both of those dial ins is 10,121,638. 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, July 24, 2018, the 10 ks most recent 10 ks we filed on 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. This call will also refer to certain non GAAP measures, that's Generally Accepted Accounting Principles, non GAAP measures. A reconciliation of these measures with the most directly comparable GAAP measures can be found in our Q2 2018 press release, which is available on our website at centene.com under the Investors section. Finally, a reminder that our 3rd quarter earnings results call will be held on Tuesday, October 23rd at 8:30 Eastern Time, followed by our next Investor Day on Friday, December 14, which as always will be held in New York City.
And with that, I'd 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 Q2 2018 earnings call. During the course of this morning's call, we will discuss our Q2 results and provide updates on Centene's markets and products. We will also discuss the recent Pinera's Care acquisition closing. And additionally, we will provide commentary around the healthcare that is legislative and regulatory environment.
Let me begin with Fidelis. We are very pleased to have closed the acquisition effective July 1. I would like to remind you of the strategic and financial benefits of the transaction. Fidelis is a diversified leader in government sponsored programs across the state of New York. Fidelis takes a local approach to providing high quality affordable healthcare to low income vulnerable populations.
New York is the 2nd largest Medicaid managed care state. With Fidelis, our New York health plan, Centene is now a leader in 4 of the largest Medicaid managed care states. Fidelis is ranked number 1 in state sponsored programs in New York. It is the fastest growing New York Medicaid and managed long term care plan as well as the 2nd fastest growing New York Medicare Advantage plan. It is the only plan to operate Medicaid, CHIP and managed long term care plans in all 62 counties in the state.
Through the incorporation of our data analytics tools such as Interpreter and RxAdvance, as well as case management and clinical programs, we will be able to further build upon the quality of care and enhance the existing capabilities of Fidelis. We expect the transaction to be immediately accretive to GAAP EPS. We anticipate high single digit percentage accretion to adjusted EPS in the 1st 12 months following the close and lowtomidteens percentage accretion to adjusted EPS in the 2nd full year following the close. We also anticipate generating approximately $25,000,000 in pre tax net synergies in the 1st 12 months and $100,000,000 in pre tax net synergies in year 2. These synergies will primarily be attributable to our medical management programs and specialty services.
On a run rate basis, we expect Fidelis to add over $11,000,000,000 in revenue and over $500,000,000 in adjusted EBITDA including net synergies. The planning portion of the integration process was completed prior to closing. Our integration team did extensive work to provide a smooth and seamless combination. We were able to hit the ground running the day of the close and the integration is progressing as expected or better than expected. Next, I will provide an update on the healthcare legislative and regulatory environments.
In early July, pursuant to discussions with the Department of Justice, the administration took the position to freeze the risk adjustment payments for 2017 2018. This is pending its appeal of the New Mexico Federal Court's decision. The administration along with congressional leadership has made it clear that they are seeking a timely resolution of this matter. We expect that CMS will bring clarity and a fair resolution to the issue. Last week, we were pleased to see that CMS set an interim final rule to the OMB that would allow for the resumption of risk adjustment payments.
Consistent with our approach to sound public policy Centene will continue to advocate for the risk adjustment program to continue in the manner for which it was designed. Now on to Q2 2018 financials. We were pleased to report another strong quarter marked by solid top and bottom line growth. Membership at quarter end was 12,800,000 recipients. This represents an increase of approximately 585,000 beneficiaries over the Q2 of 2017.
2nd quarter
revenues increased 19% year over year to $14,200,000,000 The HBR decreased 60 basis points year over year to 85.7%. This was attributable to growth in the marketplace business and the reinstatement of the health insurance fee. The adjusted SG and A expense ratio increased 30 basis points year over year to 9.6%. This was primarily related to the growth in our marketplace business. We reported adjusted 2nd quarter diluted earnings per share of $1.80 As previewed at our June Investor Day, this excludes the $0.12 charge to reflect a retroactive charge in California's minimum MLR.
Consistent with our expectations, adjusted net earnings have developed in a quarterly pattern similar to last year. Jeff will provide further financial details, including updated 2018 guidance in his prepared remarks. A quick comment on medical costs. We continue to see as well as anticipate overall stable medical cost trends. This is consistent with our expectations in the low single digits.
Moving on to market and product updates. First, we'll discuss recent Medicaid activity. During 2018, we began operating under a statewide contract with Illinois' Medicaid Managed Care Program. Implementation dates varied by region and most of the membership came on during April. This expanded contract significantly increased Centene's footprint in the state.
At quarter end, we served approximately 330,000 beneficiaries representing a sequential increase of approximately 120,000 members. Additionally, Centene will be the sole plan serving the state's foster care program. This contract is expected to commence in the Q4 of 2018. This membership will be incremental to the 330,000 beneficiaries I just noted. Florida.
The May 17 successfully reprocured its contracts providing physical and behavioral healthcare services through Florida's statewide Medicaid Managed Care Program. We have expanded our presence under the new contract and will now be operating statewide providing comprehensive MMA and long term care services to all 11 regions in the state. Additionally, Centene will remain as Florida's sole child welfare specialty plan in all 11 regions. The new contract is expected to commence December 1, 2018 and runs through September of 2023. Iowa, also in May Centene was awarded a statewide contract for Iowa's Medicaid Managed Care Program.
We are pleased to have won this contract as it was a re procurement of an existing contract and Centene was not an incumbent. The Iowa Health Link program provides integrated Medicaid managed care coverage including long term care and behavioral health to over 600,000 beneficiaries in the state. This contract is expected to commence on July 1, 2019. Washington, as part of the state's re procurement process Centene was selected to serve Medicaid beneficiaries under the Apple Health Managed Care Program in 4 regional service areas. We will be serving a total of 5 RSAs once it is fully implemented.
This new program now initiates fiscal and behavioral health. The contract will be phased in 2 stages, the first commencing on January 1, 2019 and the second on January 1, 2020. Centene continues to serve all regions through our foster care program in Washington. Kansas, in June Centene successfully reprocured its contract to serve Medicaid beneficiaries under the KanCare program statewide. This new contract is expected to begin January 1, 2019.
Next, Centurion, Arizona. In May Centurion was awarded a contract to provide comprehensive healthcare services to detainees of adult and juvenile detention facilities in Pima County, Arizona that commenced on July 1. We are providing a wide array of medical, dental, behavioral health services to the county's daily population of approximately 1900 detainees. Additionally, Centene renewed correctional contracts in Florida, New Hampshire and Tennessee. These new contracts all commenced on July 1.
Now Health Net Federal Services. In July Health Net Federal Services was awarded Next Generation Military and Family Life Counseling Program contract. Under this contract, we will deploy licensed behavioral health counselors on assignments throughout the United States, U. S. Territories and countries where U.
S. Military is deployed. The contract term is up to 10 years including multiple 1 year option periods. On the Medicare, at June 30, we served approximately 344,000 Medicare and MMP beneficiaries. This represents a year over year increase of more than 16,000 members.
With the close of the Fidelis acquisition, we are now serving Medicare Advantage members in New York. We remain focused on building a successful Medicare business over the long term. We expect this business to be a significant driver of our annual growth rate. Next, health insurance marketplace. The marketplace business continued to perform well in the Q2 consistent with our expectations.
At June 30, we served over 1,500,000 exchange members representing sequential decline of approximately 100,000 beneficiaries. This is due to normal attrition and is in line with our expectations. Including Fidelis, we now serve and offer exchange products in 16 states. Shifting gears to our rate outlook, we continue to expect a composite Medicaid rate adjustment of an increase of approximately 1% in 2018. In conclusion, our strong second quarter results are for continued evidence of Centene's financial strength and operational capabilities.
The acquisition of Fidelis further enhances our scale and position as a diversified healthcare enterprise and leader in government sponsored healthcare. Our pipeline of growth opportunities remains robust. We are positioning Centene for the future by continuing to invest in systems, people and other capabilities. This will enable us to sustain our growth as well as continue to expand our margins. We thank you for your continued interest in Sensene, and I will now turn the call over to Jeff.
Thank you, Michael, and good morning. This morning, we reported strong Q2 2018 results with total revenues of $14,200,000,000 an increase of 19% over 2017 and adjusted diluted earnings per share of $1.80 an increase of 13% over last year. Earnings for the quarter were driven by the performance in the 2018 marketplace business providing a favorable HBR. Additionally, we had higher investment income during the quarter due to the funds associated with the Fidelis acquisition and higher interest rates that was offset by a slightly higher tax rate as a result of revisions to our share of the health insurer fee. I will provide more details on this in a minute.
Additionally, during the Q2, we completed the previously announced MHM acquisition and completed the financing transactions for the Fidelis acquisition, which closed July 1. Let me provide some more details for the quarter. Total revenues grew by approximately $2,200,000,000 year over year, primarily as a result of growth in the health insurance marketplace business, the expansion in new programs in many of our states in 2017 2018, including the Illinois contract expansion and the Pennsylvania LTSS program, acquisitions including MHN, CMG and Foundation Care, the return of the health insurer fees for 2018 and as highlighted at our June Investor Day, approximately $500,000,000 of pass through payments from the State of California received in the Q2 that were recorded in premium tax revenue and premium tax expense. This growth was partially offset by lower revenues in California associated with the removal of the in home support services program from managed care, which took effect in January of 2018. Moving on to HBR, our health benefits ratio was 85.7% in the Q2 this year compared to 86.3% in last year's Q2 and 84.3 percent in the Q1 of 2018.
The decrease year over year is primarily driven by the growth in the marketplace business and the reinstatement of the health insurer fee in 2018. This was partially offset by recognition of the changes associated with the California Medicaid expansion MLR rebates. As we highlighted at our Investor Day in June, we recorded a reduction in revenue and earnings of approximately $30,000,000 pre tax associated with the changes in the MLR rebate. This increased our HBR for the quarter by approximately 20 basis points. Sequentially, the 140 basis point increase in HBR from the Q1 of 2018 is primarily attributable to the seasonality of the marketplace product, which has a lower HBR in the Q1 due to the effect of deductibles and the recognition of the California MLR changes, which I previously mentioned.
These HBR increases were partially offset by the decrease in fluke related costs over the quarter of 2018. Before I get into SG and A, let me provide an update on the marketplace business. The reconciliation of the 2017 risk adjustment benefited the quarter by approximately $79,000,000 pre tax and was in line with our expectations, consistent from a percentage perspective to prior year and as such was included in our guidance. As widely publicized, the risk adjustment transfers for 2017 had been suspended. We did not change our accounting for the risk adjustment program and continue to utilize the statewide average premiums to record our risk adjustment estimates for 2017 2018.
We will await final determination on the issue before we consider any potential adjustment to our accounting. Just to size the potential effect, if the risk adjustment program were to use each carrier specific premiums versus the statewide average premiums, our net risk adjustment payable would decrease by approximately $100,000,000 pre tax for the 2017 benefit year. Again, our Q2 accounting remains consistent with prior periods. Now on to SG and A. Our adjusted selling, general and administrative expense ratio was 9.6 percent in the Q2 this year compared to 9.3% last year and 10.3% in the Q1 of 2018.
The year over year increase was primarily a result of growth in the health insurance marketplace business, which operates at a higher SG and A expense ratio. The sequential decrease is primarily due to the open enrollment cost incurred in the marketplace product in the Q1, lower acquisition related expenses and lower variable compensation costs. Additionally, we spent $0.04 per diluted share on business expansion costs during the quarter compared to $0.07 per diluted share last year. Our effective income tax rate for the 2nd quarter was 36.9% compared to 40.1% in the Q2 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.
Additionally, as mentioned earlier, our tax rate was negatively affected during the quarter by a true up associated with our estimated portion of the health insurer fee. Now on to the balance sheet. Cash and investments totaled $15,000,000,000 at quarter end, including $3,500,000,000 held by unregulated subsidiaries. As a reminder, total cash and investments at the end of the quarter included the capital raised to complete the Fidelis acquisition, which closed on July 1. 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 $6,300,000,000 and there were no borrowings on our revolving credit facility at quarter end. Our debt to capital ratio was 36.7 percent excluding our non recourse mortgage note and construction loan compared to 42.1% at the 2nd quarter last year and 40.3% at the Q1 of 2018. Consistent with our past practice, we used equity as a significant component to fund various investments and acquisitions completed in the Q2 as well as to fund the Fidelis acquisition, which closed earlier this month. We ended the 2nd quarter with a debt to capital ratio that was 360 basis points lower than the Q1 of 2018, excluding our non recourse debt. Our medical claims liability totaled $5,000,000,000 at quarter end and represents 44 days in claims payable compared to 43 days for the Q1 of 2018.
The increase in DCP is a result of growth in the health insurance marketplace business, growth in new and existing markets and the timing of claims payments. Cash flow used in operations was
$526,000,000 in
the 2nd quarter. As expected and highlighted during our Investor Day in June, cash flow for the quarter was negatively impacted by the repayment of approximately $630,000,000 to the State of California for rate overpayments. In addition, we expect approximately $400,000,000 to be paid to the State of California during the remainder of the year for the Medicaid expansion and MLR rebates. Before we discuss the changes to our 2018 annual guidance, let me spend a few minutes updating you on the Fidelis acquisition. As Michael mentioned in his comments on July 1, 2018, we acquired substantially all the assets of Fidelis Care for approximately $3,750,000,000 of cash.
The integration is well underway and we expect to achieve half of the $25,000,000 of year 1 synergies in 2018. Additionally, we continue to expect the transaction to deliver our previously communicated accretion targets. Now on to our annual guidance. We have increased our 2018 annual adjusted diluted earnings per share guidance by $0.03 to reflect the performance in the 2nd quarter, and we have updated our annual GAAP EPS guidance for the following items. 1st, an increase of 0 point for the Q2.
2nd, a decrease of $0.12 per diluted share to reflect the impact of the retroactive minimum medical loss ratio changes recognized in the 2nd quarter under California's Medicaid expansion program that we previewed at our June Investor Day. Finally, a decrease of $0.03 per diluted share to reflect an increase in acquisition related expenses associated with the Fidelis Care acquisition. In summary, our updated full year 2018 guidance is as follows: total revenues of $59,200,000,000 to $60,000,000,000 GAAP diluted earnings per share of $4.25 to $4.57 adjusted diluted earnings per share of $6.80 to $7.16 HBR of 85.9 percent to 86.4 percent SG and A ratio of 10.2 percent to 10.7 percent adjusted SG and A ratio of 9.4percentto9.9percentandeffectivetaxrateof34percentto36percent and diluted shares outstanding of 198,700,000 to 199,700,000 shares. Just to note that the share count is for the full year and not the 3rd and 4th quarters. The 3rd and 4th quarters will include the shares issued to fund the Fidelis acquisition and will be closer to 209,000,000 to 210,000,000 shares.
Additionally, adjusted net earnings has continued to trend similar to last year. In summary, we were pleased with the strong performance in the Q2 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. And we will now begin the question and answer session. And our first questioner today will be Steven Valiquette with Barclays. Please go ahead.
Great. Thanks. Good morning. Thanks for taking the question. Good morning.
Hey, good morning.
So, we're getting a few questions around the risk adjustment payments. I guess as you mentioned, it was a benefit of $79,000,000 but also last year $48,000,000 $70,000,000 the year before that. So from my point of view, it doesn't really seem to be a trend out of the ordinary. And kind of as you suggested, it was in your guidance. Just to me, it seems like it's a pretty consistent trend and there's no change in accounting, but maybe just more color on why people may be seem to be kind of concerned about this.
But to me, it seems like they're pretty consistent trend. Thanks.
Well, I'll have Jeff give you a little more detail, but you got it precisely right. So the accounting has been consistent, margins percentages, this is something we've been doing this business for 5 years now and our accounting group understands it, knows how to book it and it is in the guidance. And Jeff, you may want to give a little more color around that.
Yes, yes. Just I mean, I agree with your comments. I mean, I guess our view is to Michael's point, it's been consistent. We've been doing this program for 5 years. There's, I think, more stability.
You have to go back to last year and remember that we had added conservatism to our guidance last year for the exchange because it was post election. So fast forward to where we are today, there's more stability in the program and we have a track record and certainly a history of having development on this estimate just like we have on IBNR and any other estimate that we have in the business. Okay.
That's helpful. Thanks.
And our next questioner today will be Steve Tanal with Goldman Sachs. Please go ahead.
Hi, guys. Just I guess following up on that, just a broader question on the exchanges in 2019. With respect to the risk adjustment program as well as the mandate going away, how is that affecting your approach, if at all? What do you expect to see on the exchanges in terms of market share shifts or competition? Any comments there would be helpful.
Kevin, do you want to comment on that?
Sure. Hi, good morning. We remain very bullish about the exchange business both for ourselves and also the stability of the market. So we're expecting ongoing growth in our business. We think it remains very, very stable and we're very enthusiastic about open enrollment coming up.
Yes. Remember the past couple of years, we retained 80% of the previous year's enrollees, which I think speaks for itself.
Perfect. And I guess just a separate question, just 2 of the deals that were done in the quarter, MHM Services and Community Medical Group, would be curious if you could break out bigger than the quarter, I guess, I'd just be it would be helpful to know what kind of revenue and earnings to expect from those 2 companies going forward?
Joe? Yes. We didn't give any specific revenue or earnings guidance on those. Just a couple of things I can tell you on where those revenues show up. For CMG, there is some risk based revenue there.
So that shows up in our premium revenue. M H M is going to be in the service line.
Okay. That's helpful. Thank you, guys.
And our next questioner today will be Josh Raskin with Nephron Research. Please go ahead.
Thanks. First question, just around the timing of Texas Star Plus. It sounds like there's a resubmission that you guys have been asked to give, I think, 30 days as of a week ago or so. So is that a full resubmission, you've got to resubmit responses to the entire RFP or is that just going to be responding to the updates? Just trying to get a better sense of the timing.
Chris, I'll ask you to respond to that.
Thanks, Michael. Josh, as far as we know, the RFP was issued late yesterday. We do, as you mentioned, have 30 days. It's due on August 22. And as far as I know, it is a full resubmission of the RFP at this point in time.
And they have moved the projected implementation date from Oneonetwenty to Sixonetwenty as well.
Okay. Sounds pretty I mean, it sounds like a full blown RFP resubmission in 30 days sounds tough. So I guess I was a little surprised to hear that.
Well, I think one has to be prepared to deal with those kinds of issues and we are.
Right, right. I guess you guys are in good shape. You've already submitted. So really probably have most of the answers. The second question, I'm just curious around a more clinic based model for Centene and what the benefits would be to have more sort of brick and mortar type centers, even if they were leased or partnered or whatever, and how that would impact the Medicaid business specifically?
And then I guess, if there's other commentary around the exchanges or MA for a clinic based model that'd be helpful as well?
Yes, I think I've commented at Investor Days and other conferences that we're not out there buying all the practices we can and all the clinics that we can. We said that the group in we brought in Florida, CMG is scalable if we need it. And it will serve us well to be able to move into underserved areas, where there is not an adequacy of position. Pick a county in Texas or somewhere with more rural. This gives us that opportunity to open up a clinic and they can do it efficiently and quickly and protect our membership in that concept.
And they have a very efficient operation. They operate with highest of quality, low MLRs and so we saw that as an opportunity to have an asset that we can apply where needed versus just simply saying it's a national strategy. They serve all the government services, Medicaid, Medicare and the exchanges. Okay.
So Michael, you would say you don't really need broad based clinic help across all of your markets and some sort of retail strategy isn't what you're looking for in there?
We're not trying to buy clinics and have clinics in every market. We're focused where they're needed or whether to do with physicians that are not going to work with you, we have the capability to go ahead and protect the access that our membership needs. Perfect.
All right. Thanks.
Thank you.
And our next questioner today will be Kevin Fischbeck with Bank of America Merrill Lynch. Please go ahead.
Hey, great. Thanks. So just wanted to go back to the risk adjusters for a second. So you're saying that you're the way you're accruing is the way that you've always been accruing for it. But if this lawsuit was to go and be, I guess, be upheld, then your thought is the risk structure methodology would change in a way that would essentially be favorable to you to about $100,000,000 related to last year.
Is that the way to think about it?
Yes, yes. We quantify 2017. It's really what we've quantified. I mean, who knows how the ultimate resolution is going to come out. But I think what we've quantified is the difference between using the statewide average and carrier specific premiums on the 2017 benefit year.
And that was the $100,000,000 pretax that I gave you.
And your point is that 2017, you were probably a little bit more conservative just because of all the uncertainty there. So if you were to think about the 2018 or 2019 run rate number, it might be a little bit less than that $100,000,000
No, no. What I'm saying is if you look at 2017, the $79,000,000 that's disclosed in our 10 Q, I think it was $48,000,000 in the prior year and you take that as a percentage of the year end balance, it's roughly 10%. So it's very consistent year to year. And we are using that same methodology for 2018 and the business has actually grown.
Okay. All right. That's helpful. And then I guess I wasn't clear if you respond to this in your commentary on the exchanges. If you did, I apologize.
But with the risk adjuster methodology, I guess payments being withheld, does that change at all how you're submitting your rates for next year? How you think about next year? Is there anything any conversation with the states about kind of a dual submission process with risk adjusters, without risk adjusters, old methodology, new methodology?
Kevin? Hi, it's Kevin. No, it's not. We're very confident that we'll be able to maintain, as other carriers are, the rate timeline submission deadline. We're tracking to that and so we feel comfortable with it.
Okay. All right. Great. Thanks.
And our next questioner today will be Lance Wilkes with Sanford Bernstein. Please go ahead.
Good morning. Two questions for you, kind of D. C. Policy related. One of them is, as you're hearing about drug policy and drug pricing policy, Be interested in your thoughts as to what the implications might be to the to your Medicaid business and the public exchange business of a range of approaches that might include elimination of rebates or shift to like a fixed discount model?
And the second question was going to be just trying to understand if you thought there were any policy responses to risk adjustment or corrections there as opposed to just an appeal on the court case?
Yes, I think there's 2 of them. On your first question with our Rx Advance, we're moving ahead with our Rx program, which we believe will be proven to be much more efficient and it's all predicated on what the pricing is. If they come up with a program without the rebates, we have the capability to deal with that very efficiently and effectively. And we're becoming a large enough supplier of pharmaceutical products and purchaser of them that we'll be able to buy quality or quantity very effectively and efficiently and put that together with RxAdvance and I think we'll be in a very strong position versus just a traditional PBM. So that part I think will work very well.
We also as it relates to the risk adjusters, we have the stated policy that we are comfortable with where it is. We believe it will advocate for maintaining it as it is and not look for any short term benefit for ourselves, but saying this is a matter of public policy, it's been working, let's leave it alone.
Got you. That's helpful. And just to be clear on the rebates aspect of it, I would think that from the businesses you're in, which are more fully insured businesses, if there was a conversion to sort of a net pricing business model as opposed to the current rebate model, that you would be relatively indifferent. But I wasn't certain if that's exactly how it would work on the Medicaid and on the public exchange side. Is that a fair way to think of your exposure?
I think with the system capability we have, we can be indifferent to it because we can very quickly adjust to whatever methodology they're using. So we're very comfortable with either one and have planned for it, recognizing this could easily happen.
Great. Okay. Thank you.
The next questioner today will be David Windley with Jefferies.
It's Dave Styblo in for Windley. First question
is just a little
bit more about the exchange outlook for next year. We've seen a number of new entrants to the market in some of those in some of the areas that are in your footprint. Just curious to get a sense of how much of your footprint do you have visibility on for new competitors? And in terms of pricing, it seems the market has become a little bit more aggressive this year, perhaps that's just because at MLR, they're reaching their MLR floors. Curious if you had any comments about what you're seeing broadly across the landscape?
Yes, I'll start off and then let Kevin comment. I've always thought it was a positive thing to have competition. And I learned a long time ago, as in consumer packaged goods, when there's 1 in the market, it's incumbent on them to grow the category in the market. When there is 2 or 3, you end up with more noise in the market, more awareness of it and not one company trying to build a category. So I welcome the competition.
We've demonstrated that we can deal with competition effectively and continue to grow and really we tend to use as obviously showing with just our capabilities versus theirs. Anything you want to add, Kevin?
Kevin, just to completely agree with what Michael said. We welcome the competition. We think that it's an example of the ongoing growth and stability of the marketplace. As you guys are probably aware, we have expansion plans going into next year, both in adding new states as well as expanding in existing states. So again, we think the increased new entrants is a very good sign for the marketplace and we're ready to bring it on.
Great. That's helpful. And then you guys have provided some additional disclosure for the books of business in terms of revenue. When we try to triangulate some math around that, it looks like we get to government net margin that might be just under 2.5%. Would you roughly agree with that?
And then is there room to expand margins on that business excluding M and A accretion from Fidelis?
You're talking about the Medicaid when you say the government, you're talking about the Medicaid line, right?
Yes, exactly, not the commercial line.
Yes, I mean, I'm not going to comment about our specific net margins. There's always room to expand margins. Scale, I think helps. Additionally, all the states are different, right? So it's a portfolio approach for us.
So there's always room for improvement and we always look to do that over time.
We have a steady goal of expanding margins.
And our next questioner today will be Sarah James with Piper Jaffray. Please go ahead.
Thank you. Was hoping you could walk us through some of the sequential tailwinds between 2Q and 3Q. It'd be really helpful if you could break that out into M and A related and other areas that you're looking for improvement. Thanks.
You mean from this quarter to our Q3? Is that what you're specifically asking about?
Yes, I am.
Yes. I mean, I think the biggest thing you have to realize going from Q2 to Q3 and this is the same from Q1 to Q4 is just how the marketplace business performs, right. So it's always the lowest in the Q1 and it pretty much trends up from there all the way to the Q4. And then you have the Q4, which includes all the open enrollment costs. It also includes the enrollment costs for Medicare as well.
So I guess what I would expect is HBRs would increase from here consistent I think with what Michael said and what I said in my prepared remarks, which is this year from an adjusted earnings perspective is developing pretty much consistent with last year.
Any other tailwinds that you're looking for either from M and A or from medical management
on the program?
Yes, obviously, the Fidelis acquisition, right, comes in on July 1. So that's significant and we're glad to have that. The other thing is that we mentioned the CMG, M H M and some of the other transactions that we did. Those are obviously will benefit the P and L, but from a size perspective is less than of a needle mover. So Fidelis interest rates have also continued to increase, which has been favorable as well.
Then where is Centene looking to expand to in 2019 for exchanges? And can you help us size the impact on pricing for the bid that when you include the removal of risk adjusters? There's been some reports that it's in the 20% range,
one, we have to see what's happening in this, adjusted. So we deal as we typically do with the here and now. And I hate to say this, Sarah, but we'll talk more about 2019 in our December guidance call, which is when we typically talk about the next year. But as we relate to the other part of the question, we just say we're going to treat it as it is now, because there's no basis. You start doing all the what ifs.
I think that's where you get turned sideways and our success has been just that. Look at it, make a decision and go forward. Does that help?
Thanks, guys. Thanks, Michael.
Thank you.
And our next questioner today will be Matt Orsz with BMO Capital Markets. Please go ahead.
Yes, thank you. I was hoping you could comment on the enrollment drop in group commercial. I know I asked about that business on the recent investor event. And I'm sorry if I missed something that you previously said about that.
Louis, go ahead. Sure.
Hi, good morning. Yes, the enrollment drop in the group business, which you've just alluded to, is really a reflection of pricing discipline and market discipline that we've been bringing to that business. Frankly, as you guys know, that's a philosophy that we bring to all our products in all our markets. And obviously, we all need to make choices and figure out the right pricing and the right discipline to bring. So it's a manifestation of that.
Maybe just to add on to that question, my own comment is we've heard that California is seeing somewhat more intense price competition. Would that then can I infer that would dovetail with what you're talking about?
Yes. And again, but that discipline is not limited to any specific state. It's something that we bring to all our markets and all our products.
Okay. Thanks. And can you just as we now step closer to Medicare Advantage open enrollment, are you getting any sense for we're hearing snippets of information, maybe rumor that are you getting any sense for where you may be positioned relative to competitors?
I think we're looking at it on an ongoing basis, but it's probably too early to make a specific comment.
All right. Thank you.
Our next questioner today will be Peter Costa with Wells Fargo. Please go ahead.
Good morning, everyone. I think we beat
the risk adjusters to death here. So I won't ask that.
There always has to be one issue, Peter, that we beat it down.
So I'd like to move on down to the income statement a little bit and understand about the health insurance feature up a little bit. How much of that is true up just in this quarter? It went up $12,000,000 from the Q1. Should we be thinking about that going up every quarter the same amount, or so $183,000,000 each quarter from here? And then how much of that is offset in terms of Medicaid picking up the tab for the premium in premiums versus what's in commercial or say Medicare where there'll be a headwind to earnings?
Yes. So that's specifically what I commented on my prepared remarks. No, you're exactly right. There was a true up this quarter. And how that true up comes about is, we're estimating how much our fee is compared to the entire industry, right.
So we're using information from 3rd parties to figure out what the denominator is in that. And we got new information that the denominator changed a little bit. And so we increased the health insurer fee. Now on the Medicaid side, that's a pass through, predominantly a pass through, that's how we treat it. So you're recording the additional revenue and expense and it offsets the net earnings line.
On the commercial side, that is not. Our premiums don't change. We bid premiums and so those don't change. So that was a little bit of a bad guy in the tax line, if you will. And that's what we mentioned in our prepared remarks.
And that really offset what I would call the additional investment income that we had really from the capital that we had on the books for the financing of the Fidelis transaction. So what I would say is, I think going forward Q2 or Q3, Q4, I think it would be relatively consistent with what it was in the past, a little bit less than what you saw this quarter.
So a little bit less than this quarter, meaning back down to the $171,000,000 or meaning?
Right around yes, I'd say north a little north of $175,000,000
Okay. And then in terms of the interest income item that you mentioned here, that was up quite a bit in the quarter. You said most of that was related to the Fidelis Care cash balance, but how much was interest rates and how much of that will continue going forward?
I think there I mean, there's a little more than $10,000,000 that was just on the Fidelis Capital. So that can give you an idea of what it was. Okay. That helps. Thank you very much.
Our next questioner today will be Mike Newshel with Evercore ISI. Please go ahead.
Thanks. Jeff, I think, I mean, you already clarified this, but just to make sure, it sounds like you're framing the annual second quarter risk adjustment true up as more of a recurring benefit relative to the size of each exchange premium base that we shouldn't treat as a non recurring item. That's right. So basically yes, so basically that 2017 benefit you're recognizing in 2018, should we think about as being offset by conservatism embedded into the payables you're accruing for the 2018 plan? Yes.
Absolutely. And that should flow through to earnings next year in Q2 of 2019? Yes. Assuming, of course, there's no change in the program, is that the right way to frame
it?
That's exactly right.
And we and I anticipate it will be as close to accurate next year as it were this year.
Got it. And then maybe just a second one then. So when you closed the Fidelis acquisitions, was there any evaluation on the reserves or adjustments made in the asset purchase?
Well, we haven't so that closed July. So we haven't we're not reporting our valuation exercise associated with the Fidelis transaction. We have the first time we'll see that is when we report Q3. So we've begun our procedures on that. Obviously, we did a lot of planning for that, but we've kicked that off and that will be the beginning of the fair valuation exercise that we'll complete within 1 year from the balance sheet date.
All right. Thank you.
The next questioner today will be A. J. Rice with Credit Suisse. Please go ahead.
Hi, everybody. Hi. Continuing to beat the dead horse on the risk adjusters, is your 5% pre tax margin outlook for the exchanges in 2018 inclusive of the $79,000,000 risk adjuster accrual?
Yes, I believe we've said it's I think my commentary specifically was higher than 5 and below 10 at one of our Investor Days. So yes, yes, it is. When we look at the margins, when we're giving those margins, that's what I would call a fully complete reconciled with the government margin number.
You have to do it when you're included in guidance, you have to be
That's right.
Right. So, I know originally you guys had talked about and for some time had talked about long term profitability on the exchanges being in the 3% to 5% range. If it sounds like you're running 5% or north of that now. Is there any updated thought on what the long term profitability of the exchanges might be?
No, I think you're right. We've had a lot of history with the product and it's performed consistently year over year. That's why we ultimately changed our 3 to 5 and updated that to north of 5. For competitive reasons, I'm not going to get into the actual margin number. But it's a very good product for us.
Okay. But you're saying you think the north of 5 is sustainable basically?
Yes.
Okay. And then just this is a technical cleanup. On the California Medicaid expansion MLR retroactive adjustment, I think you're saying that the $0.20 headwind was in the reported 85.7 percent MLR, but you're taking that out when you on the adjusted EPS calculation of $1.80 I just wanted to confirm that.
Yes, that's true. In my prepared comments, I mentioned that it was a 20 basis point increase to the HBR for the quarter. We don't provide an adjusted HBR number. So I just gave you the 20 basis points.
Okay. All right. That's good. Thanks a lot.
Thank you.
And our next questioner today will be Zad Sotkat with Morgan Stanley. Please go ahead.
Thanks for the question. I just wanted to go back to the contribution from Fidelis for the second half of the year. Is it fair to think that the cadence of the contribution is going to follow the same path as Centene historically has in 3Q and 4Q?
Yes. Excluding the exchange business, the marketplace business, right? You're talking Centene historically prior to the marketplace business?
Yes. I guess, I'm talking about adding Fidelis, because I think of the contribution being the same as your general cadence between 3Q and 4Q or is there something that's going to change the overall timing due to the accretion from Fidelis?
No, no. I would say that, yes, they would follow what I call a traditional Medicaid earnings path for a year. So you have flu season which kicks off in Q1 or Q4 and can go into Q1. And so those months are usually or those quarters are usually the highest HBR quarters, the summer months a little better. So yes, I think it would follow that same seasonality path because they're predominantly Medicaid.
Okay, got it. And a question back to the marketplace. So with CMS adjusting again the amount that they invest in Navigators, Are you thinking again about how you're going to invest, I guess, in advertising in general for the marketplace going into next year? And should we think about that at a similar level as we saw coming into this year?
Yes, that's yes, similar level. I would say it's larger actually because the business is larger for us, right? And we're planning for growth in 2019. But that kind of goes back to the whole risk adjustment comment. If you go back to last year, in the Q2, we had the risk adjustment that was pretty much offset by the additional costs that we loaded into the Q4 of 2017 because the government limiting marketing.
Those costs are already included in our 2018 guidance, which is one of the reasons why we included the risk adjustment favorability as well. Both items are in. And those costs are actually higher than they were last year because of the size of the business.
Okay, great. That's helpful. Thank you.
And the next questioner today will be Justin Lake with Wolfe Research. Please go ahead.
Hey, thanks guys. Appreciate the question. So on risk adjustment, I want to make sure I've got it completely correct. So it sounds like I'm almost completely and exactly wrong in that you're saying that you put up a pretty significant reserve for adverse deviation every year on this thing?
Yes. Just for the record, before Jeff responds, you said that, I didn't.
It's always fun to be publicly incorrect. So let's just make sure I have this straight. Yes. So Jeff, you put up with the same reserve. It looks like it's north of 10% of your of what the spot number ends up being, you're putting up 10% plus?
Yes. What I will tell you is that's an actuarial estimate, of course, and it's done by state. That's also net of minimum MLRs. So, the calculation is actually more complicated than just aggregating the business altogether and taking 1. And obviously, there are a lot of carriers that have had problems with this in the past.
So yes, we have had a, what I'd call, a consistent reserve for adverse deviation and that's been you can see that in the actual results and how it's played out over the last 3
years. And where it's interesting is because the business is actually growing, the deviation reserve you are putting up for this year for 2018 is actually even bigger from a headwind perspective than the tailwind you are getting for last year?
That would be an accurate statement. We are using the same methodology that we have used since the beginning of the program. The only thing that's happened is we've gotten more states and the business has grown.
All right. And then let me just you said this is in guidance and obviously I think you guys at your word. The thing that was confusing is last year, was it in guidance for 2017 because you beat the 2Q when you had this true up benefit, you beat by $0.30 versus consensus. And you had it very clearly in the write up that you had this $0.17 beat. That's where I think at least I got confused because it looks like it was upside last year and this year it wasn't.
So can you was it consistent or was this the 1st year you didn't you decided to put it in guidance? Can you clear that up for me?
Yes, yes. I mean, I hate to go all the way back to December of 2016, but you have to remember where we were in December 2016. It was post election. And if you recall, we actually added $0.20 of conservatism for the whole marketplace product as a result of the election. So at that point in time, we did not include the risk adjustment in the number, in the guidance.
But post that, we've seen stability in the market. We have a consistent level of development. So heading into this year, because we had the costs, right, remember, in 2017, when we had the favorability in Q2, we added the costs to Q4, pretty much offsetting that because the government was limiting its marketing. So fast forward to this year, the costs were in, the benefit of the risk adjustment in, really driven by stability in the program and we were comfortable enough with our estimates and what the costs were going to be for the year. So it was in guidance, yes.
Got it. So in 2017, it wasn't in guidance and you did that from a conservatism perspective because of everything going on.
That's right.
And 'eighteen, it was in guidance. And going forward, it will be in guidance. So we should expect this to occur. You'll basically just assume that this occurs at 10% or plus of whatever the reserve is each and every year?
Yes. Yes. And there has been consistency in the past. I do want to be careful. It's an estimate, right?
We're estimating it. We've had very consistent track record of estimating it, but we are using the same methodology that we have used since the beginning of the program.
And I just want to emphasize what Jeff said earlier, that it's not 10%, it's market by market evaluation that then gets rolled up by our accounting folks.
All right,
guys. Thanks for all the color. Appreciate it.
The next questioner today will be David MacDonald with SunTrust. Please go ahead.
Good morning. Just a couple of quick questions. One wanted to come back to RxAdvance. You've obviously had that relationship now for a handful of months. Can you just talk for a minute about are you already starting to see some of the efficiencies around administrative costs?
And also has it noticeably improved your visibility around gaps in care and the ability to decrease some of these drug impacted medical costs?
I'll start off and Jess can pick it up. But it's been a couple of months. And that would be a lot to see in a couple of months. But Jesse? Yes, I think let's put a couple of kind of pieces
of context around that. One is to Michael's point, we're in the kind of the roll out process. So it wouldn't be fair to comment on kind of specific visibility, but we continue to have confidence that the efficiencies that we have referenced are there and those benefits will continue to accrue as we expand the offering in the future.
And then guys, just one quick follow-up. How do we think about with regards to Fidelis the pacing of the expansion of services at Fidelis? How quickly you expect to roll out some of these additional services and just any visibility around that?
Well, I think it's going to be a function of we're working on the medical management and we've already been planning for it through the prior to close, we planned the rollout. I'm not going to lay out the whole plan of when medical management is coming in, case management, interpreter and the other things. Jeff?
Yes, yes. I mean, obviously, we're trying to it's a big component of the synergy capture. So we've been planning on this for quite some time, and we are accelerating those as fast as we can.
Okay. Thank you.
And by the way, we have a very willing recipient. They've been sitting there waiting and biting at the bit, so to speak, to get at it.
And our next questioner today will be Gary Taylor with JPMorgan. Please go ahead.
Hi, good morning. One clarification and then two quick questions. The first, Jeff, when you talked about the $400,000,000 for the California MLR rebate remainder of the year, that's simply a cash flow item already accrued, correct?
It's actually it's regulated capital. It is already implications. That's regulated capital going back to the state that's been accrued since the Fidelis acquisition or since the Health Net acquisition, sorry.
Okay, thanks. Question, was there a material outpatient provider rate increase under the Florida Medicaid program during the quarter?
A couple of things I will always say. There's retroactivity in the business. We're operating obviously in several states across the country. And I would say this is common in Medicaid programs where there's retroactivity. Some are positive, some are negative.
But we always see a certain level of retroactivity. That's the benefit of scale and diversification is that you're matching those things up and you're using a portfolio approach. So what I would say is, yes, there was some fee schedule changes, but I would say across the Centene Enterprise in total, nothing out of the ordinary.
Okay, understood. So, not material enough to call out given the portfolio's performance. That's a positive.
That's right.
And then last one is, just specifically, hospital trends. So we came out of Q1 with hospitals, at least the for profit hospitals hospitals showing higher not just acuity, but higher same store revenue, most of the payers still saying overall hospital trend is fairly stable. Is there any color on your overall hospital trend?
No, I would agree with those comments. I think it's pretty consistent.
Okay. Thank you.
And the next questioner today will be Ana Gupte with Leerink. Please go ahead.
Yes. Hey, thanks. Good morning.
Good morning.
Yes. Thanks. Can you hear me?
Yes. Yes.
Good morning. All right. Thank you. Yes. So the stocks, I mean, not just yours, but Medicaid in general has been rerating back to growth status.
And my question was about your organic growth and then your priorities for your capital deployment on inorganics. If you take a look at this year, it looks mostly like your growth is coming from exchanges and then to a smaller much smaller extent on ABD complex populations and then of a much smaller base on Medicare. So organically speaking, where do you think the growth is going to come from more? Is it going to stay more exchange driven you think or would it reaccelerate in other areas? And then secondly, on the to looking at your inorganic approaches, initially I felt like you were talking a lot about Medicare.
It's now very successfully you've done Health Net and Fidelis. Might you be thinking more about roll up as your priority or more tuck ins on Medicare? And then where does it play into your specialty and involve capabilities as far as GAAP deployment?
From the organic standpoint, I think we laid out the number of RFPs we won, the expansions taking place there. The new RFPs we'll be waiting to go live. So you will see continued growth in the Medicaid business through that form of organic growth. Relative to the inorganic growth and tuck in and things, I really can't talk too much about that. That's from a competitive standpoint and all the reasons associated with it.
And very simply, there's always they say many of you have to do a deal is done, it's not done. So I want to be very cautious and conservative on that particular one. The third part that I heard is, we continue to focus as well as on the current book of business, the Medicare, other things that we've talked about On the technology side of things, RxAdvance is a good example of that. A technology that I think will materially help us grow that business and contribute significantly to reducing costs. So we will continue to focus on those kinds of opportunities and the prison health etcetera just a very balanced portfolio growth is our objective.
Helpful. Thanks, Mike. One follow-up on the technology piece. So you very nicely showcased RxAdvance at the Eye Day. I did see John Sculley at a public appearance after Amazon announced TILPAQ and how they might need to get into cloud based PBMs and so on.
So as you think about your equity stake in Rx Advanced and tech players like Amazon potentially making a play into the drug value chain, might you see yourself driving partnerships with some of these so called Well,
I think anybody that wants to purchase at a fair price our services will be available to talk to. And I think really as people understand some of these capabilities, they're going to recognize they really need it as they move ahead. And I made some recent comments that vis a vis the things they're talking about and disruptors and I see that as a positive. And we intend to be to a limited extent disrupt ourselves with some of these technologies.
Got it. Thank you. Appreciate it, Michael.
Thank you.
And this will conclude our question and answer session. I would like to turn the conference back over to Michael Neidor for any closing remarks.
Well, I want to thank you all for your time, attention, support. And we look forward to the next call, not unlike this one. Thank you and have a good rest of the summer.
And the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.