Morgan Stanley 15th Annual Global Healthcare Conference

Sep 12, 2017

Summary

PBM wins and renewals underscored demand for cost management, while integrated clinical, pharmacy and payer capabilities supported growth. 2017 earnings were expected to skew to H2 as Part D utilization and generic timing shifted profits.

Good morning, everybody, and welcome to day two of Morgan Stanley Global Healthcare Conference. I am Ricky Goldwasser, Morgan Stanley's Healthcare Services Analyst, and it is my pleasure to introduce our first speakers for today, the CVS management team. We have, to my left, Larry Merlo, President and CEO, joined by Dave Denton, CVS's CFO. Larry and Dave, good morning and welcome to our conference. Morning, Ricky. Larry, CVS has always been at the forefront of the industry, whether it was combining the retail and the PBM, quitting tobacco, and rebranding CVS as a healthcare company. As the healthcare marketplace continues to evolve and with the changing dynamics of that marketplace in mind, what are the key questions that you as a management team and your board are thinking about as you think about CVS's positioning longer term? Well, I would describe our focus as centering on how we are positioning the CVS Health enterprise to respond to these new challenges and opportunities that are emerging as the healthcare marketplace evolves. We firmly believe that you have seen us build a broader suite of enterprise assets and capabilities. We think we are well-positioned to capitalize on some of the market dynamics that we see playing out. We have talked about many of those dynamics, whether it is the aging of the population, the ongoing increasing incidence of chronic disease, along with just what we are seeing happen in the pharma space in terms of solutions coming to market to meet unmet needs, but at very high price points. These trends certainly put a premium on not just access and quality, but how we can bend the cost curve associated with care. We have heard a lot of dialogue and discussion around how the system today rewards volume and not value. We think that whether it is through our capabilities, through the innovative products and services that we brought to market and others that we continue to work on, that we think we are well-positioned for an environment that begins to tip the scale to recognize and reward the value of care, acknowledging that those clinical capabilities will lead to reduced costs and improved outcomes. As a result, we think we are well-positioned to be a partner of choice for health plans as they focus and look to what they are concentrating on as their solutions to this cost-quality access conundrum. If we think about the different pieces, the different assets that you have, let us start with the PBM segment. Year to date, you have retained 97% of your customers. 70% of the selling season is already complete. What resonated most with plan sponsors, and what surprised you the most? Ricky, I would say as we look at the 2018 selling season, we have been very pleased with the results. You mentioned the retention rate, and we announced last month on our second quarter earnings call that we had $5.4 billion in gross wins, $1.8 billion in net new business, acknowledging the loss of the FEP specialty contract beginning in January of 2018. At the same time, we also announced renewing the FEP mail and retail contracts through the end of 2019. Just last week, we announced the renewal of the CareFirst BlueCross BlueShield plan that will allow us to service their members through 2023. I think as you have heard us describe and others describe, this particular selling season has been somewhat muted from RFP opportunities. We are pleased with the results that we have achieved to date. Ricky, back to, I think, the focus of your question, what are we hearing from clients? Obviously, much like where we started with the first question, there continues to be this focus on cost. People are very interested in what we can do to bend the cost curve, to address the trend drivers that are contributing to growing costs. You may recall when we produced our trend report for 2016, as part of that, we had acknowledged that there were almost 40% of our clients that had negative year-over-year trend as a result of adopting many of our programs, whether it is formulary management, utilization management, some of the programs to manage the specialty pharmacy costs. There is an ongoing and an increased focus, recognizing we've got a lot of best practices from similar-type clients where people are very interested in terms of exactly what did they do to experience that level of trend, and what did they incur as they made those transitions. So, we're having very productive discussions with clients in terms of what it means for them to adopt those programs. I think the other component worth mentioning is we have seen the growth in consumer-directed health plans, and we've worked closely with plan sponsors in terms of ensuring that they're using plan designs that do not have unintended consequences that are going to reduce things like medication adherence. But all in all, I think we're having very productive discussions with our clients. Yeah, Ricky, I'll just add a couple things to that. One is I do think plan sponsors today continue to be focused on specialty and the management of that specialty patient. I think our assets, if you look at how we wrap ourselves around that patient and manage that patient holistically, are very well positioned to manage the specialty patient in that environment. I think you also asked what things are surprising to you a little bit, and I think the one thing that is just beginning to get some uptake, but I think there's a long pathway to this, is the implementation of some outcomes-based, value-based reimbursement mechanism in the healthcare landscape as it relates to pharmacy. We're beginning to see that. You'll see some programs that we have out in the marketplace today, but I do think that we expect over time that those kind of programs will accelerate in their adoption, and it's been pretty slow on the uptake at this point. Yesterday, we had the CEO of the PhRMA Industry Group present here, and he kind of highlighted a growing emphasis on point-of-service or point-of-dispensing rebates. Is that something that your plan sponsors, your customers are asking for, and how do you think about, is that something that's an easy ask to implement? Yeah, Ricky, it's a great question. I think it goes back to what I was alluding to in terms of ensuring that I was using consumer-directed health plans as an example. We have the capabilities today to provide point-of-sale rebates at the pharmacy counters. We have in the process of educating our clients, encouraging them to adopt those particular plan designs. I would say that the uptake to that has been slow to marginal at this point. I think what we hear from our clients is, they want to have the flexibility to apply those rebates, let's call them discounts, in a way that they see makes the most sense for their employee or member population. I think more times than not, we hear those plan sponsors talk about using those discounts to buy down the monthly premium. Recognizing, you think about a health plan, you think about premium, deductible, and then copay. I think today, most people see the fact that the premium, that monthly premium is the most visible component. They're always looking to, how can I buy down that premium so that it's at its lowest possible cost? So, I would say that we'll probably see a bit of a step change as we move into 2018, but I do not see at this point rapid adoption of clients adopting the point-of-sale rebates. The diversified model is obviously another top-of-mind topic. PBMs and managed care organizations have always been working together, but the United Optum model is increasingly resonating with plan sponsors, and vertical integration is really top of mind for investors in our research. What would be the benefits of potential vertical integration between a health plan and a PBM? Yeah, maybe I'll start with that. First, keep in mind that if you look at our business model today with an integration of both the PBM asset and all the clinical capabilities that it has, along with the retail footprint that we support across the country that engages consumers in a pretty effective manner, we have a very integrated, vertically integrated offering that we take to market, and that program has been extremely successful. We continue to, as Larry indicated earlier, win in the marketplace from both the gross as well as the net sales perspective. So our model is still very pertinent in the market and still gaining traction. You wrap around our specialty capabilities, it further turbocharges that asset. So I think we're very well positioned against someone like an Optum United business model. Having said that, we've been asked many times, "Well, if you step up the stack in healthcare, what does that mean to you?" I will say that there are pluses to that, and there are cons to that kind of a business model. Obviously, today, we service about 70 health plans, and we support them both from a Medicare perspective as well as a pharmacy perspective. Our business model has been, as they grow, we grow along with them, and that has been very successful. We do also, in that same business model, compete in some lines of business with them, and we've been able to do that successfully with our SilverScript product offering in the marketplace from a prescription drug plan perspective. We've actually seen, even though we participate with SilverScript, we've seen the 40 or 45 health plans that also compete in that marketplace disproportionately grow and take share, even though we've taken share as well. The downside of this is, how do you manage the channel conflict associated with someone stepping into that kind of a business model? On the pro side, obviously, the more you get up in the stack of healthcare, the more you can control benefit plans, the more you can direct site of care, incent members to get to the right location to manage costs more effectively, and also enable those members to have access to the benefit plan through the pharmacy counter, which they really don't have today beyond pharmacy. I think that's the opportunity that lies with partnering more deeply with the health plan. We're actually seeing a lot of uptake even today with our partners, whether it's Aetna or whether it's Cigna, whether it's some of the Blue Cross and Blue Shield plans that we service around the country, to be able to broaden the scope of, I'll say, clinical services that we offer at the pharmacy counter to drive real benefits for them. So, I think there's been a lot of debate and topic discussion, mainly within the investment community, around those various business models. Is it fair to say, just following up on the small health plan, that some of the things that we're hearing in the marketplace is that it's really kind of like your unique position in Medicare Part D that adds value to the smaller players? When you think about within the context of the industry, do you think that there are other players in the marketplace that could fill in that spot, or is your capability really so unique that it would create stickiness even if you deepen relationships with other health plans? Yeah, I think if you just look at the scale of our business model, if from a, say, a smaller health plan tapping into that scale, we really enable them to successfully compete in the marketplace through, I will say, offering that scale advantage to others to be able to grow. I do think that that allows us some protection, if you will, from a channel conflict perspective. Yeah, Ricky, I think Dave Denton mentioned SilverScript. I think SilverScript is a good example of what we have seen. SilverScript has grown to be the largest PDP plan out there today, with about 5.5 million lives. Yet, at the same time, we are managing the Part D benefit for many health plan clients. As we look at their growth, even though they compete with SilverScript, they have grown faster than the overall PDP market. I think that that is a good testament to the capabilities that we have are providing them differentiation. At the same time, the marketplace is big enough where SilverScript and their product can compete effectively and see above-market growth. I think the other important point in all of this is, you have heard us talk about this retailization of healthcare, where the consumer is bearing more of the accountability. With that accountability becomes decision-making. With the decision-making comes the tools with which to make those decisions that I think we would all agree are probably lagging some of the plan designs. Part of those tools becomes the education. I think the fact that a common denominator across many of our assets is that we deliver the last mile of care to that patient. So, the ability to influence the behavior and help to provide the education for those patients, I think is probably an underappreciated part of the assets that we operate, and I think will play a growing role that will be important to a broad cross-section of clients. Moving to the retail side, but still staying on the health plan relationship, you are going to be part of Aetna's Part D preferred network in 2018. Can you just kind of walk us through that strategy. Obviously, you moved away from that preferred network a few years ago. Now you are back in the network. What is your strategy for PBM preferred networks going forward? Yeah, I don't know that our strategy's materially changed as we thought about our Medicare Part D approach to the marketplace. From a retail perspective, we've always looked at partnering with Medicare PDPs and MAPD plans across the nation, and really go through a fairly sophisticated underwriting process to make sure that the economics are both good for the plan, but also good for CVS Pharmacy. What you have seen happen is that most of those Medicare Part D plans have grown. Many have grown in the chooser space versus the low-income subsidy space. Obviously, when you're participating and plugging into a plan that has a lot of chooser lives, they have a lot of opportunities to construct benefit plans and copay incentive plans from a preferred relationship perspective that move share and members around from a network perspective. So, you've seen us lean in to plans where we can partner with them, add a lot of value economically, move share into our channel. At the same time, when they move that share into one of our channels, we clinically improve performance, therefore drive Star Ratings and incentive payments into their plans more dramatically based on the set of assets and capabilities that we have. So, I think you're just seeing the natural evolution of that market, and you've seen us disproportionately be in a preferred status as we cycle into 2018. When you think about the potential impact from Aetna specifically, I know there's been kind of like a range of potential earnings impact across the street. Any sense there? Yeah, I think we've underwritten them. I can't probably give you some specifics on it. It'll also depend on how they do in the market this year. So, as they begin to offer their program late in the year when the open enrollment period occurs, it will depend on how they and other members that we support, other health plans that we support in the PDP space, how they perform from a marketing perspective. So, we'll probably get a lot more color on that as we cycle to the end of this year and into the first quarter of next year. This is also the first year that you opened Maintenance Choice to other PBMs. With the information that you have now, how has that been progressing in the potential impact and volume, and has that been a factor? Yeah, I think what in the outlook for this? Yeah, just to kind of step back, what we have done and what we said at the end of last year is that one of our plans to return to healthy operating profit growth is to partner more deeply with payers in the marketplace, including other PBMs as well as health plans. As we've done that, there's been a couple of proof points. One is an offering with Optum, another one is an offering with Cigna, more recently around how we're bringing a 90-day network solution to the marketplace for them that drives value for them and share gains for us. So we're progressing nicely from that perspective. Keep in mind that the product, the Maintenance Choice product, is still very relevant in the marketplace. We continue to sell that aggressively into our book of business, and the uptake continues. It has been about seven years or eight years since we first introduced the product, and it is just now being, I will say, somewhat replicated in the marketplace. Keep in mind that if you go back in time, the reason why Maintenance Choice was so powerful at the time, not that it is not powerful now, but was probably economically more powerful back seven or eight years ago, is the generic penetration was not at the levels it is today. From a consumer and a plan sponsor perspective, you were trading off three 30-day branded copays for one 90-day branded copay at mail, and that drove a lot of value to the member. Now, with an 87%, 88% generic dispensing rate, the same economics are not available to the consumer because now they are taking generics more rapidly or more aggressively, which is a good thing in total, but it negates the economic point at some level, the copay differential between Maintenance Choice. So what we have done, what we have enabled is now the consumer's choice to be able to have that flexibility to receive 90-day scripts at CVS or use the mail channel, whatever is most efficient for them, and you are seeing people migrate into retail out of mail from that perspective. Ricky, I think an important I will ask a follow-up question to that really parallels where Dave was going is, does offering some of your services that up to this point had been, I will say, exclusive for Caremark members, does that dilute the PBM offering? The answer to that is no, because we are continuing to innovate on the PBM side of the house. We are in the process of getting ready to launch a Maintenance Choice 3.0 version that will provide patients, beneficiaries some additional convenience elements, and while preserving the economic advantages that Maintenance Choice offers for both client and member. We also announced our Transform Care programs, the first one for diabetes, where we are actually in a position where we can cap the drug costs for that particular client. This will be the first of, we expect to have three additional Transform Care programs out in the market within the next 24 months. So, we are continuing to innovate to bring some disruption to the market, if you will, with some unique products and capabilities that go back to that cost-quality access conundrum. On the topic of disruption, Amazon. Obviously, we've been getting a lot of questions on Amazon's strategy into healthcare. There's been a lot of news, media reports on that topic. Front-end comps have been obviously under pressure for a while now, as consumers continue to adopt omnichannel. While the healthcare marketplace has been obviously notoriously difficult to penetrate, it's also a market that might be ripe for some new perspectives. How do you think about Amazon, both as a risk, but is there also an opportunity? Well, listen, you never underestimate the potential threat of another competitor entering the marketplace. But I think as probably everyone here has heard others and ourselves comment on, pharmacy is not a commodity product. There are significant barriers to entry, whether it's the regulatory environment in which pharmacy operates or the fact that the complexity of pharmacy, when you think about the clinical capabilities required, the fact that more than 90% of all prescriptions dispensed have some form of insurance coverage. So you're playing a triage role between pharmacist, physician, payer, and the complexities that that creates. You think about an online-only offering that I would say that that is probably not sufficient in today's marketplace. If you look at mail order penetration in pharmacy, it's less than 15%. It has been on the decline as a result of innovation that we just talked about, whether it's Maintenance Choice, Specialty Connect, or the growth in 90-day plan designs broadly across the industry. So I think that those are all substantial challenges to a new entrant entering the market. That said, I think certainly CVS, I think the industry will continue to innovate. We've seen threats in the past, okay, whether it was, remember the days of the $4 generic in terms of how that was going to change the dynamic in the marketplace, and the industry figured out how to compete against that. So, I do believe that today we are well-positioned. We're continuing to define what omnichannel means for our customers and clients. I think the industry will rise to any challenges from any new entrants. Now, some of your competitors have commented on an openness to potentially partner with Amazon. Would you be open to a partnership, and is there any value to that type of an arrangement, either on the PBM side or the retail side? Yeah, Ricky, I mean, listen, we would never rule anything out. I think if a new entrant, any company, came to market with a new, cost-effective way to provide pharmacy care, we would certainly be interested in understanding that and participating in it. Moving to 2017 earnings guidance, cadence this year is more pronouncedly back-end loaded due to the timing of Medicare Part D. In conversations with investors, the level of visibility around Medicare Part D and utilization trends comes up a lot. Can you just help us understand the underlying economics that drive the cadence? Sure. Also, as a follow-up, when you just think about guidance, taking into account the fact that the last months we have seen some pretty tough weather conditions, both in Texas and Florida. Yeah. How should we think that in context of the numbers as well? Yeah. First, just for context, in Medicare Part D, you are subject to the federal government's plan design, and that plan design assumes certain risk corridors that you hit based on utilization within your book of business, and you underwrite to that. Typically, in the first half of the year within a Medicare PDP plan, the plan sponsors, us and SilverScript, you do not make any money. In fact, in some quarters, you actually lose money. You then, when those members hit the certain thresholds where the reinsurance corridor kicks in, that is when the plan sponsors begin to earn profits. That is typically in the back half of the year based on utilization trends in your book of business. What you are seeing this year is pretty typical, is you are seeing those utilization, those members move through their benefit plans a little slower than what we have seen in the past, partly because the absence of hepatitis C treatments that we have seen in past years that accelerated utilization in the front half of prior years. So, that is disproportionately pushing income into the back half of 2017. Our book of business within Medicare Part D continues to grow, so not only are you seeing that shift occur within our book, the absolute number of members moving through those benefit plans is actually increasing. So, that is driving the cadence, and it is pretty much as we expected. So, we are not seeing from if you looked at our internal estimates and our internal budgets, we are very much on plan. Secondly, you are also seeing just the timing of break-open generics in 2017 is also back half loaded, so you are seeing disproportional movement of profits from first half to second half. Again, very consistent as we outlined back at Analyst Day in December. As it relates to, I guess, the weather conditions, if you look at Houston and Texas, the first storm, we did experience some disruption. Obviously, it is very immaterial. We have very few stores that are not up and running today. Do not expect that to be any material headwind. As we think about Florida and what is occurring there, that is obviously a broader storm affecting many more regions. I would say we do not have a handle on that at this point in time specifically. I will tell you that we are very well insured from an asset perspective, so I think you will not see a material impact on that as well. But we are probably in the early stages of assessing the situation there. I do think the storm was probably less severe than what was originally worried at the beginning, although I do think it is affecting now up into Georgia and the Carolinas that probably was not anticipated as well. But probably more to come on that as we think about it going forward. Great. Well, Dave Denton, thank you very much for you and Larry Merlo for being here today, and looking forward to your third quarter earnings call. Thanks for hosting. Thank you. Thanks, everybody.