Morgan Stanley 17th Annual Global Healthcare Conference

Sep 10, 2019

Summary

Early post-merger progress included strong Q2 results, HealthHUB traction and disciplined medical cost management. Priorities included nationwide CarePass rollout in Q4 2019, faster-than-market Medicare Advantage growth in 2020, and ~$800 million in 2020 synergies.

To day two of Morgan Stanley's Global Healthcare Conference. I'm Ricky Goldwasser, Morgan Stanley's Healthcare Services Analyst, and it is my pleasure to introduce our first speakers for today, Larry Merlo, President and CEO of CVS Health, and Eva Boratto, CFO. Larry, Eva, welcome to our conference. Before we start, I just need to remind you all that for all important disclosures, you can go to the morganstanley.com website. With that, Larry, 2019 is the year for CVS. You're putting together the foundation for kind of like the new enterprise. Maybe we can kick the conversation by you making some introductory remarks just to kind of like to help frame the year and the conversation. Sure. Well, Ricky, thanks, and good morning, everyone. It's great to be here. Ricky, to your point, it's been about nine months now since CVS and Aetna became one company, and we feel really good about how we're executing against our strategy, acknowledging that we are in the early stages of our transformational journey. The progress that we are making as a company was evident with the results that we posted for the second quarter. We delivered strong operating results, including strong revenue and share gains across the enterprise with all of our businesses performing at or above expectations. We continue to be laser-focused on four key priorities that we outlined at a June investor day. That is to grow and differentiate our businesses, deliver transformational products and services, the third being to enhance our consumer-centric technology infrastructure, and finally, to modernize enterprise functions and capabilities. Now, with respect to transformation, we are encouraged by the early results of the initiatives that we're putting in place, some of which are gaining traction across our enterprise. Just to give you a couple of examples, I know everyone's heard about the HealthHUBs. In these stores, we're reconfiguring our store layout. We've begun to introduce new health and wellness products and services. Over the long term, that will certainly drive revenue and profitability at retail. We're encouraged by the results that we're seeing in Houston. You saw we announced plans to go to additional markets in the second half of this year. We're also introducing new health insurance offerings, and in our PBM, our adherence programs, our formulary compliance initiatives are delivering more value and creating better health outcomes for our clients and the members that we serve. At the same time, we have been working to reduce overall operating costs as well as evaluating additional opportunities to accelerate growth opportunities across the enterprise. On that note, I'd be remiss if I didn't acknowledge last week's announcement. I'm sure all of you saw the fact that the long-awaited decision by Judge Leon related to the Aetna transaction is finalized. We applaud Judge Leon's decision that supports the value that we create every day for the clients and customers that we serve all across the country. It is important to note that there is nothing more that we need to do from a regulatory perspective as it relates to integrating the two businesses. Ricky, maybe I will wrap up before we jump into Q&A. I just want to reiterate the confidence that we have in our plan to create greater value for our shareholders through creating this innovative new consumer-centric healthcare company. While it is still early, we are delivering tangible results that are in line or above the expectations that we provided. Ricky, with that, I will turn it over to you. Great. Thank you, Larry. Larry, you started by talking about growing and having a differentiated strategy, and it seems that retail anchor is a key differentiator compared to other models in the marketplace. Maybe if we start really talking about retail. Front store growth really outperformed the market. It has historically, but I think this quarter was meaningful. In the guidance that you provided for next year, I think you surprised all of us by saying that you are expecting to grow retail next year as well. Can you talk a little bit about what is driving the performance, and how do you think about the sustainability? Yeah, Ricky, and one of the elements driving performance, it has been in the works for a while now. We have talked a lot about our personalization strategy using our loyalty program as a differentiator to drive revenue, and at the same time, revenue that has a flow-through to the P&L. We are seeing those various programs working, and we still think that there is additional runway associated with the personalization strategies. We have continued to have a broader focus on the core categories within the store, health, beauty, personal care, and we are gaining share in those areas. At the same time, there is a lot of focus on omnichannel, and we have been working to define what omnichannel means for our customers. You have seen us do a number of things, whether it is home delivery or office delivery, if you will, especially here in the city, as well as the development and now nationwide rollout of our CarePass program, which is a subscription service that we began to test last year in one market. We expanded it to an additional two markets, and we are very confident and very pleased with the uptake that we saw in that pilot. You saw last month again that we announced a nationwide rollout that will begin in the fourth quarter. How do kind of like narrow networks, preferred networks, or that enterprise approach play into the front end and just the retail comps that you have? Yeah. Ricky, there are a lot of things that we're also working on in terms of, how do you think about extending that pharmacy experience into the front of store? A lot of that goes back to our focus on those front store health and beauty personal care categories. You think today that there are elements of, I'll call it sick care, that are reflected in our front store offerings, but there's also an opportunity to migrate that to a focus on wellness. How do you take care of things from a more preventive point of view? The fact that there are elements of the personal care and beauty categories that also speak to the wellness aspect of health. We're seeing some traction on those various programs. Ricky, if I could just expand on what Larry said. Longer term, you asked the question about durability, right? As we see our community assets, which our retail stores are at the center of, we see three ways we're going to create value, right? What Larry described around the products in the store, the different services, enhanced utilization of MinuteClinic, bringing additional traffic, the medical cost savings that we can deliver through that site of care, where value will accrue to our enterprise, as well as utilizing these assets beyond Aetna in our open market. We think longer term, that's how we see the store to continue to evolve. Building on that, if we think about kind of like the HealthHUB, what are you seeing in the markets where you're at? You're in Houston, you said that you saw good results, but how does that tie to that confidence that you have in the improved performance of the store? Well, Ricky, first of all, it absolutely validates the beliefs that we have reflected in our strategy. As you mentioned, it gives us the confidence to move more quickly and broadly across the country. Eva touched on the value creation that, yes, there is value creation within the four walls of the HealthHUB, if you will. We are seeing increased utilization of MinuteClinic. We are seeing new pharmacy customers as a result, and we are really pleased. We took out almost 3,000 SKUs in the front store. We did add some new health offerings, but we are really pleased with the front store sales that we are seeing as a result, as well as the overall margin profile of the store. Again, that doesn't reflect the opportunity that by improving the health of those we are serving, there is a cost reduction, medical cost savings that flows through to the healthcare benefits segment of our business. Then, as Eva mentioned, there is a tremendous amount of interest in terms of what is happening in the HealthHUB, especially from our Caremark clients, and the opportunity to make many of those products and services more broadly available in the marketplace. One last question on retail. Walmart, a couple of years ago, announced their own health clinic strategy. On one end, it is kind of like just another validation of the overall strategy. But how do you think about that marketplace now in terms of competition? Well, Ricky, listen, I think that as you would expect, every company is working their strategy in terms of what they believe is right for their company. I do think what we are seeing is a validation of the emergence of what we have been talking about, whether you use the phrase the retailization of healthcare or the emergence of the retail health consumer, and the need to meet people where they are, the need to make healthcare local, whether it is in the community, in the home, or for many of us, now the palm of your hand. To your point, we think it is a validation of the journey that we have started, and we are very confident in terms of the assets and capabilities that we have that can bring our strategy to life in a meaningful way. You talked about kind of like the end goal of really lowering the medical spend via the use of that retail asset. It's a good segue to the Aetna business in how we kind of like look at trends in medical costs. Last quarter, managed care companies across the board reported higher MLRs, I think the street was expecting, and we got a lot of inbound questions around the overall competitive environment. How would you characterize the market? Yeah. Ricky, I'll start, and if Larry wants to jump in. Overall, in terms of MLRs, I'll speak to what we saw and what we're seeing in the marketplace. In terms of development and prior year development, what we've seen to date is largely in line with the experience that we had in 2018. I would say we haven't seen any material changes in the underlying marketplace. There'll always be instances where a competitor wants to go more aggressively after an account, but we'll continue to utilize our disciplined underwriting process and evaluate the economics of those choices. If the economics don't make sense, we'll choose to pass on that business. I'll add one thing. As we look longer term, we're really confident in the assets that this combined company is bringing together to enable our Aetna business to be competitive in the marketplace. Some of the programs that we've developed, as we spoke about on our earnings, we implemented in our bid strategy, and we're working through the commercial side. Just to kind of dig a little bit further into that, you talked on your call on some pockets in the commercial, I think, in the low end of the commercial business that saw some increased competition. What was kind of unique to that market? Yeah. I would say so, as context, to step back, right? Where we saw some pressure was in the, what we call the middle market segment, the 51 to 100. It was not pervasive. It was select geographies across the country. What we're doing, what we have started to do, what we've done is ramp up our medical management programs in those areas. And we have not seen anything that leads us to believe this is a more pervasive challenge for us. Ricky, I just want to also emphasize that as you look at the government business, we saw tremendous growth in the Medicare segment this past year, and we're very pleased with the medical trends that we're seeing in that space, as well as what we're seeing in the Medicaid book of business as well. Can you talk a little bit about your MA pricing strategy for next year? I mean, obviously phenomenal growth in 2019. What type of growth are you targeting for next year for that book? Yeah, Ricky, Eva just touched on the fact that we're excited with some of the additional offerings that will be available for MA beneficiaries for 2020. And that reflects the uniqueness of this bigger company, and we'll see how that plays out in the market. But we expect to continue to grow at above-market rates. We're not going to put a quantitative number on that today other than the fact that we expect to grow faster than the market. Let me just stop here and see if we have any questions, because we do try to make these sessions as interactive as possible. So if anyone has a question, please raise your hand and we'll get you a mic. There is one over here. Hey, guys. Good morning, Ari. Can you offer a little bit more insight on the HealthHUB? I believe you said on the call that the comps and the traffic were both up. year over year. Usually my experience with retail resets is it goes backwards before you go forwards. So maybe just a little bit of a deeper dive in terms of what categories saw explosive growth to overcome the pullback in SKUs, as OTC was up four times. What is it? Did you drive more people into the store, and why was that the case? Or did you get better tickets out of the people that came into the store? Yeah, Ari, just maybe a couple points on that. To your point about, yes, when you go through a reset period, there is some disruption as you move things around. We've got a lot of experience over many years, and we have figured out a way to contract that period of time to a few weeks, okay, that we're not going to have stores ripped up for months, okay? So, there is a disruptive period, but we saw an immediate reaction. Keep in mind, it's a small number of stores. The Houston market will be complete in the near future. We have not turned on any broad marketing activation that you would once you complete a market. So, to your point, we've talked about the front store focus being on health, beauty, personal care, and some elements of convenience. So, we've contracted some of the general merchandise categories in the store, but we have seen revenue more than made up in health, beauty, personal care. That's where we're seeing strong growth. Okay. Going back to kind of like the Aetna business and cost trends, I think historically cost trends for Aetna were at around the 5.5%-6%. Obviously, when we think about the integrated model, the power of the integration longer term really should yield a kind of like lower cost. So, based on your early experiences and kind of like the pilots that you've been doing since you closed the transactions, by how much do you think you can bring that cost trend kind of like over the long term? Ricky, I will start. I think it is, we haven't given long-term cost trends, right? There are many external dynamics, factors affecting that. As you know, as we look at the synergies and some of our early plans there, the medical cost savings take longer to bear out. What I would say is if you look at external analysis, that we've seen medical cost trends are expected to continue to increase over time. We believe that the initiatives that we're deploying, whether it's chronic care, Alan has spoken about our kidney care program, chronic disease management, and some of the programs that we're implementing, that we have an ability to offset some of the market dynamics. Okay. Moving on to the PBM segment. It's interesting because I think that we've yet to see a fully integrated PBM in health plan business. When you think about that opportunity, where do you see opportunities in the near term to bring together the health plan and the PBM in a truly integrated manner that can help lower consumer out-of-pocket costs? Well, Ricky, we're going to have that opportunity as we move into the 2021 selling season. Look, I think it reflects a lot of the things that we talked about, that how do you create a surround sound model, acknowledging that pharmacy continues to play a bigger part in overall healthcare costs? Especially when you think about specialty pharmacy, when you think about that component of specialty pharmacy that is managed through the medical benefit. You kind of have that bifurcation, if you will, of pharmacy in two different places. I think we have some very unique opportunities with which to create a more seamless experience for clients and the members that we serve. Again, we'll be talking about those as we move into the selling season. When you think about a 2021 selling season, that's starting to ramp up as you're wrapping up the 2020 selling season, what's the feedback from your customers? What are they asking for? Ricky, it really picks up on your last question. There continues to be a focus on cost for obvious reasons, as well as complexity. We have heard from clients that, look, in an effort to bring solutions to the challenges that I face as a decision maker for thousands of employees, I am talking now on the commercial side, I have more vendors than I have ever had. The complexity associated with that is, it is extremely difficult to manage. I think it is reflected in the comment that I made earlier that, can we create more of a turnkey, surround sound solution to simplify things for that benefit manager without compromising? Actually, it is not a question of compromising, it is furthering, enhancing the achievement of their goals around a service offering for their employees at the appropriate cost. I think the point of sale rebate rule has been shelved, but there is a lot more awareness to the notion of point of sale rebate in patient out-of-pocket spend. I mean, if it did something, it created that discussion. How are your customers thinking about it? Do you expect to see more point of sale rebate as part of your offering for the 2021 selling season? Yeah, Ricky, listen, it is a great question, and probably the last time we were here, if you had asked that question, we had said we had about 10 million Caremark members whose plan sponsor had adopted point of sale rebates. As we sit here today, that number is probably closer to 12 million. But Ricky, one of the things that we are working to educate our clients, especially those with high deductible or consumer-directed plan designs, we saw the definition of how one can utilize HSAs. We saw some change in that definition over the last several weeks. We believe that that creates a further opportunity to see more adoption of point of sale rebates, and we now have a lot of information that we can share with our clients that I think there is a misnomer today that, as a plan sponsor, if I adopt point of sale rebates, it is all or none. That is not the case. A plan design that is a high deductible with an HSA, with the utilization of a preventive drug list, a plan sponsor can find that they can apply somewhere between 20% and 40% of their rebate dollars for their members while they are still in the deductible phase, and still have dollars remaining with which to buy down that monthly premium. I do believe with that dynamic in place, we will see more adoption of point of sale rebates than the year-over-year trajectory that we have seen in the past. With rebates behind us, what other initiatives do you see in Washington that keep you up at night? I mean, we get a lot of questions around the ban on spread pricing. Feedback seems that the cost savings that are associated with it are fairly limited. How concerned are you with the likelihood of that passing? Ricky, maybe I will start and then Eva can jump in as well. First of all, I would just sit here and say for the next, what, 12, 14 months, I think it is important for all of us to separate policy from politics, okay? There is going to be a big difference. Ricky, you mentioned the rebate rule as an example. I think the other dynamic is, look, whatever comes down the pike is going to have to be scored, and we saw that dynamic play out with the rebate rule. I would sit here and say that scoring process validated the role that PBMs play broadly across the industry in terms of reducing the net cost of pharmaceuticals. So, I think that is an important dynamic as to whatever it is that is next in Washington. We are seeing a lot of. Obviously, there is a lot of rhetoric and bills in both chambers of Congress, in the various committees, a lot of discussion around spread pricing. Look, as we look at spread pricing in our Medicaid book, it has been migrating away from spread for the last few years now. So, there is a relatively small amount of business, spread business remaining in the Medicaid book. As you look at spread pricing in the commercial book, as you have heard us talk many times, we have got a variety of contract designs that we think it becomes the client's decision as to what contract design is most appropriate for them to achieve their goals as a business. But, look, if spread pricing was to move away, again, we have got a variety of other contract designs. As long as there is ample time with which to make the transition from A to B, we have done that in the past, we will do that again. Okay, great. Operating cost. Part of the plan is really kind of like reexamining the cost, streamlining it to better align with the new platform that you're putting together. Can you just update us on the progress? It seems that every quarter you've been able to up those synergies and cost-cutting opportunities. Yeah, I think, Ricky, as we look at First, we're quite pleased with how the integration is going and the value we're delivering, and you're going toward the synergies. I think as we look at the value that's been created, it's typically what you would think. It's the integration of your overhead, your staff areas. It's synergies in your procurement as well as your medical cost savings. I would say the first two areas are the areas that we've really been able to accelerate some of the savings or exceed some of the initiatives that's driven the outperformance. Going back to your formulary point or your rebate point earlier, the Aetna accounts have adopted our standard formulary more rapidly, enabling us to not only deliver value through improved procurement, but also value through generating just earned at the same rate. We continue to be pleased with our progress on that front and continue to expect that as we look toward 2020, about $800 million of synergies with the annual run rate of $900 million there beyond. Larry, you touched in your prepared remarks on just the ongoing strategic portfolio review. As you think about the different assets and you review them on a quarterly basis or an annual basis, what metric are you using to think through what should be part of the portfolio and what you could divest? Mm-hmm. Yeah, Ricky, first of all, there's a few things that we're looking at, and it really starts with, in this new company, what is the strategic role that each of the businesses play in bringing our vision to life? At the same time, we've always had a robust series of metrics that vary by businesses in terms of what's important. Again, as you've heard us talk about, we're in the process of a very systematic review, okay, of each of those components. You saw that we recently closed the divestiture of the retail Brazil asset, what, last month? July. July. So, that's just one example. That work is ongoing. Okay, great. So- And- Yeah. Ricky, just we have one second left to just add to that, right? We've also spoken to looking at working capital and improvements, and we're really pleased with our inventory reduction initiative on the retail side, as well as ongoing review of our leases as they come up for lease renewal, what are opportunities to optimize as we look across our base. Okay, great. Larry, Eva, thank you very much. Okay, thanks, Ricky. Thanks, everyone. Thank you.