Good morning. I will be your conference operator today. Welcome to the UnitedHealth Group Second Quarter 2013 Earnings Conference Call. A question and answer session will follow UnitedHealth Group's prepared remarks. As a reminder, this call is being recorded.
Here are some important introductory information. This call contains forward looking statements under U. S. Federal securities laws. These statements are subject to risks and uncertainties that could cause actual results to differ materially from historical experience or present expectations.
A description of some of the risks and uncertainties can be found in the reports that we file with the Securities and Exchange Commission, including the cautionary statements included in our current and periodic filings. This call will also reference non GAAP amounts. A reconciliation of non GAAP to GAAP amounts is available on the Financial Reports and SEC Filings section of the company's Investors page at www.unitedhealthgroup.com. Information presented on this call is contained in the earnings release we issued this morning and in our Form 8 ks dated July 18, 2013, which may be accessed from the Investors page of the company's website. At this time, all participants have been placed in a listen only mode and floor will be opened for your questions following the presentation.
I would now like to turn the conference over to the President and Chief Executive Officer of UnitedHealth Group, Stephen Hemsley.
Good morning and thank you for joining us this morning to review our first half twenty thirteen and the longer term future we continue to build at UnitedHealth Group. The performance of the quarter and the first half of this year reflect many of the themes we are focusing on with intensity across UnitedHealth Group. Growing by serving more people with higher and more consistent quality with compassion and a better, more modern and personal consumer experience. Making health care more affordable by enabling the health care consumer, the care provider and the system itself to become a more effective system of health and wellness advancing the performance and value of this enterprise for shareholders through operating and capital disciplines in both growth and strategic diversification as well as dividend and share recapture. We see several of these elements in our first half performance in a number of ways, such as the consistent broad based growth across each of our market facing business groups, medical cost trends that have remained in check and will help to keep health benefits affordable the increasing pace in product innovation and adoption as nearly 6,000,000 consumers now embrace our incentive product design and our rapidly growing portfolio of consumer tools.
The rapid acceleration of deeper and more integrated performance based payment relationships with care providers that will reach above $25,000,000,000 by this year end and the increase in our dividend to more than $1,000,000,000 annually even as we sustain $3,000,000,000 in share buyback. We have a great deal more to do. We are far from performing to our potential. Although we are seeing steady advancements on many fronts, we are redoubling our commitment to consistent execution in the core fundamentals of our businesses. We are determined to accelerate the pace of innovation and the adoption of simpler and more modern approaches and technologies and ever better approaches consistently delivering higher quality care and access and to make healthcare more understandable and affordable for both the individual consumer and for our society.
Our performance in the first half of twenty thirteen was characterized by this growing business momentum, continued service expansion and diversification across the enterprise. In the Q2, UnitedHealth Group earned $1.40 per share, up 10% year over year with revenues over $30,400,000,000 up 11.5% year over year. As expected, the consolidated operating margin decreased slightly year over year by 30 basis points as the consolidated medical care ratio increased 20 basis points to 81.5%, reflecting our continued strong growth and diversification into government benefit programs. And accelerating growth from our services, international and fee based business produced a 90 basis point rise in the consolidated operating cost ratio to 15.9%. The level of services growth has become so meaningful that it continues to outstrip steady efficiency gains from our multiyear initiatives enhancing quality, simplicity and system wide productivity, as well as our concentrated focus on cost management across UnitedHealthcare, Optum and UnitedHealth Group.
While this ratio has increased, it remains largely a reflection of the ongoing growth and diversification across UnitedHealth Group. Cash flows from operations were $1,500,000,000 in the quarter and $2,500,000,000 through 6 months. We decreased our debt to total capital ratio by 160 basis points during the quarter to 34.6% at June 30 and ended the quarter with $1,200,000,000 in available cash. Last month, our Board increased our dividend by 32% to an annual rate of $1.12 per share and renewed our share repurchase program with a fresh authorization for the repurchase of 110,000,000 shares. These decisions reflect confidence in the strength and consistency of our underlying earnings and cash generation capacities into the future.
In the current quarter, UnitedHealth Group continued its pattern of steady consistent growth and market share gains. And we see more growth to come in the next few years in areas such as commercial and consumer benefits through public and private exchanges. Medicare Advantage, state Medicaid Expansions, Medicaid Long Term Care, Dual Eligible MMEs, military and veteran benefits and services, the emerging Brazilian market and the continuing maturation of Optum's broad range of services for consumers, care providers, payers and other participants in the health system as a whole. Let's review 2nd quarter business results starting with UnitedHealthcare where the story remains one of remarkable growth and continued market share gains. Over the past 12 months, UnitedHealthcare has been the fastest growing health benefits company, increasing the number of people served by more than 9,000,000.
This includes more than 2,900,000 people in TRICARE and another 4,700,000 people from a meal in Brazil, both new markets for us. Overall growth has been driven by offering distinct and innovative consumer benefits and services shaped to respond to local market needs and affordable price points for consumers. UnitedHealthcare has designed a comprehensive system of capability that aligns modern incentive based benefit designs with easy and convenient consumer empowerment tools that engage effective clinical care wellness programs, which in turn channel naturally into incentivized performance based care delivery access. This aligned system leverages better informed and incentive consumer and care provider behaviors to produce sustainable cost and performance advantages and deeper more integrated relationships with consumers, care providers and plan sponsors across all market segments. Effective incentive alignment with consumer benefits through the care provider rewards is a critical component to sustainably improving broader accountability and effective payer to care provider integration.
We are the market leaders in consumer value plans with nearly $6,000,000 high deductible or consumer incentive plans in force. We are leaders in consumer transparency tools with innovative mobile applications that enable effective use of information specific to each consumer. We're further along in value based care provider, contracting than any other company and our pace is accelerating with more than $50,000,000,000 in accountable care performance contracts expected by 2017, if not sooner. These programs offer varying levels of integration with care providers depending on their ability to affect health outcomes and assume financial risk. Year by year, these programs are helping transform how health care is delivered, paid for and rewarded.
This quarter, UnitedHealthcare's organic growth was led by the initiation of services for TRICARE in the West region for 2,900,000 members of the military and their families. This is the first time this contract has moved to a new service provider in more than 15 years and we encountered challenges as we engaged in this complex and massive transition. We have learned from these initial challenges and regret any disruption this may have caused the men and women we are privileged to serve. And we're deeply grateful for the collaborative working relationship with the Department of Defense, the TRICARE management activity, the TRICARE Regional Office West and the Surgeon Generals of the respective services, the military treatment facilities and their fine leaders. Having quickly advanced from these initial challenges, we remain to consistent excellent service and the value of innovation going forward for these programs.
UnitedHealthcare's Employer and Individual Business added a net 235,000 people year to date and is performing strongly across the board. Growth continues to be strong across the government benefit markets as well. Through the first half of the year, UnitedHealthcare remains the largest and once again fastest growing Medicare Advantage participant and Part D and Medicare Supplement both continue to perform strongly. Medicare Advantage products have grown to serve 355,000 more people through the 1st 6 months and our full array of Medicare product offerings has grown to serve over 1,000,000 more seniors this year. Medicaid growth stands at 110,000 people through the 1st 6 months despite a divestiture impacting 60,000 people earlier this year.
Care for chronic complex populations remains a distinctive capability for this business and a major forward growth driver with recent awards to serve long term care on dual eligible beneficiaries in Arizona, Florida, New Mexico, New York, Ohio and Washington State. For the Q2, UnitedHealthcare generated operating earnings of $1,900,000,000 with solid contributions from all businesses. The commercial medical care ratio improved 10 basis points year over year. We are performing slightly better on outpatient costs despite the continued migration of clinical services from inpatient settings. We continue to experience lower hospital inpatient usage as we expected and inpatient costs are in line with our projections.
Overall, 2013 full year commercial cost trends are tracking in line with our initial projections of 5% to 6% with unit prices remaining the core driver of increases. UnitedHealthcare's results include Emile, which is now 90% owned. With Emile, our international business has grown to serve 260,000 more consumers in the first half of the year, remain solidly ahead of its growth and financial plans for the year and is well positioned to continued growth and market share gains driven by its distinctive market offering and clinical engagement model. We continue to be gratified by the growing response to Optum's market leading offerings and capabilities. Each of Optum's businesses posted double digit top line gains and overall Optum revenue rose 21% over last year.
Operating margin expanded 170 basis points to 6.1 percent despite the increasing mix of pharmacy services revenues. As of today, we are more than halfway through our pharmacy migration. And since January 1, OptumRx serves a total of about 8,000,000 new consumers, including these migrations and new business. For the 1st 6 months of the year, total Optum operating earnings rose 80% to just over $1,000,000,000 Optum's strong first half twenty thirteen performance improving that the broader health system and its constituencies create a natural end market for services, a market we have sized at more than $500,000,000,000 annually. Historically, this market has been fragmented and served primarily by smaller single point solutions.
Services and capabilities we offer and provide broader, more integrated solutions to larger, more diverse clients, while continuing to deliver even more effective standalone products and services to our traditional customer base. We are focusing our investments on roughly 10 product families and freeing up resources through this more disciplined focus and the related productivity gains to fund further development and innovation on behalf of the clients and consumers we serve. These actions are driving stronger and more consistent margin performance across all Optum's businesses. The collective performance of our diverse UnitedHealthcare and Optum businesses ultimately comes through in UnitedHealth Group's strong overall results. As we indicated earlier in our commentary, UnitedHealth Group consolidated revenues grew 11.5% and net earnings grew 10% to $1.40 per share in the 2nd quarter.
We expect full year 20 13 net earnings in the tighter range of $5.35 to $5.50 per share. Our second half earnings performance will benefit from the timing of Part D earnings and contributions and Optum's continued performance gains. Our balance sheet is strong and our cash flows from operations are expected in the range of $7,200,000,000 to $7,600,000,000 this year. We already targeted returning up to $4,000,000,000 of that to shareholders and our recent dividend increase now puts us in an annual dividend payment pace of more than $1,000,000,000 Looking forward, our outlook remains consistent, strongly positive in the long term with familiar near term challenges coming in 2014 2015 as we indicated last quarter. We expect pressure on the pace of revenue growth next year given both rate and membership pressures in Medicare Advantage.
We see further business and product integration advances, further medical affordability gains, on driving lower operating costs to improve and sustain our competitive positions, serving key health benefit markets and continuing strong cash flows. The next phases of the Affordable Care Act should bring growth and expansion in the Medicaid business as well as to Optum and some meaningful financial challenges as well. For instance, on the Medicare side, the challenges intensify meaningfully and include non deductible taxes combined with the continued significant underfunding of Medicare Advantage. We remain committed to Medicare Advantage as the most valuable and fastest growing Medicare benefit offering available to American seniors. By 2016, Medicare Advantage will affect be reimbursed at parity with original fee for service Medicare.
And at same time, it will continue to deliver better benefits at lower costs because of effective medical cost management and far better consumer focused services and technologies, none of which are present in the current Medicare fee for service system. 2016 should represent a final baseline pivot for Medicare growth for years to come. And America's demographic trends are compelling. Well more than 3,000,000 people will enter Medicare each year and UnitedHealth Group is uniquely positioned to emerge as the market leader. These long term growth trends informed our approach to our 2014 Medicare bids, which will remain under review by CMS through the summer.
Our decisions for 2014 focused on balancing program sustainability, margin protection and cash flow generation of our MA business measured on a long term multiyear basis. We are aggressively and consistently addressing the operating and marketing costs of our Medicare programs without compromising the exceptional support and services we offer to the seniors we are serving through these important benefits. The depth of the underfunding of these benefits to seniors is causing us to exit certain market areas, reduce the number of plan offerings and reduce benefits in the majority of the local markets we serve, commensurate with our view of the competitive position and long term sustainability of our services for each individual market. We are shaping our networks to ensure we are delivering healthcare with local care provider partners who deliver high quality care and provide a sustainably low medical cost structure and who increasingly share in the results of collaborative efforts to bring greater quality and consistency of care to seniors, including the most elderly and those with chronic conditions. These steps can be expected to moderate member growth in 2014 in contrast to our strong growth experience over the last few years.
We will engage our members further by increasing our use of in home health reviews and in home services. Even with these actions, we expect pressure on 2014 Medicare Advantage Margins. The severe underfunding of the MA program for 2014 combined with the ACA tax impacts and continued sequestration effects are too significant a burden to ask seniors to bear alone and still expect this important franchise to remain attractive to them. Beyond Medicare Advantage and some remaining unknowns focused around ACA implementation in the individual and small group markets, we expect the general narrative of UnitedHealth Group's performance for 2014 to be largely the same as 2013. Our commercial benefits, international, Medicaid and military businesses should all continue to perform well.
Optum will continue to grow strongly and contribute comparatively more of our overall performance as virtually every Optum business and product line is growing and performing well and expected to continue on that path. We will continue to be good stewards of shareholder capital, continuing to balance investments across our businesses and returning more capital to shareholders in both dividends and share repurchase. From we have returned more than $40,000,000,000 to shareholders through dividends and share repurchase, even as we have grown and enriched the capabilities, the market positions, the value and the forward potential of this enterprise. We remain optimistic about our capacity to serve society and to create value for the people and customers we serve as well as for the health system at large. And we look forward to an expanding discussion of our strategy, growth and performance at our Investor Conference, which this year will be on December 3 in New York.
As usual this morning, we have a full complement of leaders here and would ask the operator to open the call to our questions, Holding one per speaker please. Thank you.
The floor is now open for questions. We'll take our first question from Matt Borsch with Goldman Sachs. Please go ahead.
Yes. Thank you. I wanted to just ask a little bit more about Medicare Advantage. You made a comment if I heard it correctly about final baseline EBIT in 2016 as a base for growth once we're at fully at parity. Did I hear that correctly?
And do you are you implying that EBIT is in Medicare Advantage is down from on a downward slope in 2014 2015 and then normalizing in 2016 and growing from there?
Yes. Well, I'm glad you asked the question because I don't think that if it went out that way that's not what our intent was. Basically continued funding pressures, some of the mechanical, the impact of the ACA and so forth we'll continue basically to get the funding mechanisms for Medicare Advantage to be at parity with fee for service. Once that funding is leveled at that basis, the programs are thought to then be neutral to each other from that perspective. And therefore, one could expect given the strong performance of the Medicare Advantage program that the growth could even accelerate from that point because you've got this significant demographic trend.
You have a very attractive program and the Medicare Advantage program will still have meaningful advantages in terms of benefits, medical management capacities, consumer engagement and relationship capacities that the fee for service system simply doesn't have right now. So that's why I think our outlook on Medicare Advantage in the long term is so positive because in essence we have to navigate through these next couple of years where some of the mechanical funding actions will take place. But even in those periods and those have been in my view in effect, Medicare Advantage has continued as a broad national program to prosper and grow. So I don't know how it will play out in 2014 2015 as these elements play in on the funding to get funding at essence to neutrality. But from 2016 forward that neutrality should then baseline this program and it will be Medicare Advantage with its, I think compelling advantages compared to the fee for service system.
And we think the prospects for growth after that are quite compelling. That's really what we tried to get across.
Yes. That makes sense. You also characterized in terms of next year that the impact would be to moderate member growth for 2014. Do you imply by that that you do expect growth, but it's just at a slower rate?
Well, we really didn't comment on that direction. What we were intending to say is actions that we are taking to make sure that program is competitive and viable in as many markets as we can possibly continue to advance it. So along those lines, we outlined a series of steps that we're taking and maybe Jack Larson wants to count on that. But again, we are focused on operating that program to its maximum potential and serving as many of American seniors as we can through that program and making sure that it continues to perform in terms of growth, margin protection, cash flow attributes, etcetera. And to maximize the performance of the program, recognizing the funding pressure that it's on and recognizing that there might be limitations to how much seniors can actually bear the underfunding actions that are being taken with respect to the program.
Jack?
Thanks, Steve. I would just add maybe a bit of an exclamation point on some of the changes that we're contemplating for our business next year. And I think Steve went through the well. We're looking at benefits. We're going to be adjusting our planning some market withdrawals, I think at the more modest end, perhaps 5% or so with most of those members having an opportunity to enroll in another UnitedHealthcare plan.
We'll be narrowing our networks consistent with achieving better costs, better outcomes and better management of our stars. And Matt, we haven't really seen how our competitors are taking to all this too. So I would say at this distance, I think the only thing we can really say is that our performance at the membership growth line is likely to be more moderate compared to the last couple of 2 or 3 years where we have grown very well.
Okay. Thank you.
Next question please.
And we'll go next to Justin Lake with JPMorgan. Please go ahead.
Thanks. Good morning. First, just wanted to check and see if there's any updated view you can share with us on 2014 EPS growth overall?
Well, Justin, we thought that question might come up. We don't really comment on next year's guidance in the current midyear quarter. I would say that with that said, earnings growth is clearly our focus for 2014 and we are intense about that. But we have to recognize that there is a great deal in front of us to achieve that. As we just mentioned, certainly strengthening Medicare Advantage given the significant 2014 funding shortfall and the steps we need to take to make sure that program continues to be vital is on the front of the list of that.
There's also ongoing work in the commercial markets with pressures on our own individual business, the continued market migration to lower price point insurance products and fee based conversions. And those are all occurring kind of in the backdrop of a normal competitive dynamics and tensions. We remain respectful of medical cost trends despite the success in keeping trends in check and particularly given the measured economic recovery. We need to make continued investments in the emerging categories of private exchanges, Medicare risk and revenue cycle, house calls, ever larger and longer term care provider relationships, Optum Cloud products. And in general, we are committed to continuing to fund ongoing innovation and adoption.
And then lastly, when I think about headwinds, investment income will see probably short term pressure as current portfolios actually turn over and transition from kind of capital gain realization mode into higher yielding portfolios for the longer term. So with that series of headwinds in front of us, Experience has taught us to be somewhat cautious and to be sure we consider and respond to these headwinds before we offer a sense of 2014. So we are not prepared to do that, but I would say we are intensely focused on solid earnings growth for 2014, but we have to work our way through that as we stand really in the mid year of 2013.
Great. And then my actual question was more just a follow-up on Medicare Advantage. Just to make sure I'm clear on what you've laid out here is, you feel like 2014 2015 are looking like a obviously are going to be under pressure. So but by the end of 2015 going into 2016, do you expect that 2016 growth to reaccelerate and you feel like you'll still after all this pressure given what you're doing from a cost perspective and managing you're going to have and then you feel like the benefits that you still have left out there for seniors after these cuts will still be enticing and you expect growth to be in line with what you've seen over the last couple of years and potentially even accelerate. Was that a right was that the correct takeaway?
I think you generally have it correct. I think you may have a more precise notion of it than we would having to operate the program. So I can't tell you that on January 1, 2016 that there will be some kind of light will go on etcetera. But you have exactly the direction of our thinking on this program correctly that as we navigate through the next couple of years and the pressures that I think are well acknowledged on the program, we intend to operate it in such a way that we are maintaining the vitality of that program, protecting its margins, maintaining the vitality of its benefits and its distinctions to consumers, to seniors that need these programs. And that we think that as you reach that point of neutrality, which is about 2016 that the growth dynamics of that should accelerate, yes.
And Steve, do you think
the program will be bigger than it is today or not or smaller than it is given what's facing you when you get to 2016? And that's it for me.
That's the 3rd installment of your single question. Obviously, Justin from that discussion, we expect in the long term that the needs of the American seniors and what the values we can bring to the Medicare program suggest that is a very strong long term growth platform.
Great. Thanks.
And we'll go next to Chris Rigg with Susquehanna. Please go ahead.
Good morning. I just want to follow-up on Medicare Advantage again and make sure I understand what you're talking about in terms of reimbursement and the pressures in 2014 2015. But when we think about the business near term particularly Q4 of this year and how you market to seniors, will you take your foot off the accelerator somewhat in terms of marketing? Or do you think you have to accelerate the spending this year to maintain what you have and potentially grow? And just if you could give us any context on how the spending might change year to year that would be helpful.
Thanks.
Yes. I might offer and I'll take it at my level that how we're going to approach and deploy resources in the market from a marketing point of view at this point in time is really a little I would say a level of competitive intimacy that I'd rather not share. I would say that our commentary was more along the lines of the fact that we are going to be shaping networks to be more focused, to really focus on the high performance assets as it relates to seniors that the benefit reductions that are fairly broad based. Those are the elements that I think will play into more conservative growth prospects for 2014. I think that getting into what our marketing plan is might be a little bit more than we would like to get into this morning.
Thanks a lot. Sure.
And we'll go next to A. J. Rice with UBS.
Thanks. Maybe I'll switch gears a little bit. There's been some developments obviously around the ACA since we last had you guys on the conference call of the employer mandate delays, some documentation delays. And then we've also gotten information on the exchanges in some states. I know you've said you'd be opportunistic particularly around the exchanges.
Can you comment about, A, does any of those developments that have occurred in the last few months change your perspective on those opportunities that are available to you maybe looking out next year and beyond for the ACA?
I think I'll have Gail and Jeff Walter kind of comment on that. I would say again like to calibrate the perspective we're bringing to it. Long term, we're positive with respect to those channels. As they form and as they become areas where we think we can participate and add value, The near term dynamics are more challenging for us and maybe that's specific to our particular profile of business. So near term, we have tended to be more cautious with respect to those.
And I think generally, the elements that have been occurring reinforce those tendencies.
Good morning. It's Gail Boudreaux. I think Steve hit on the core principles. We've been I think, modest in our participation in the exchanges. But I think the biggest story quite frankly is there is significant change going on across the overall commercial market.
So as we think about our business, we're focused both inside and outside of the Exchange around affordable benefit offerings for our consumers. So what we're talking about in terms of our network and our intentional integration of product, clinical and network strategy is really core to both what we're doing inside and out of the exchange. We're participating in about a dozen exchanges as you can see from what's been publicly disclosed. And quite frankly at this stage of the game, we've kept a very disciplined process around that. We think there's a huge opportunity over the long term and we're going to participate to learn in those exchanges.
In terms of what's happened on the overall reform implementation at this stage, we're preparing our business. And as I said, much of what we're doing, we're doing for both inside of the and outside the Exchange because we think affordability and consumer engagement are probably the most critical pieces.
Okay, great. Thanks a lot.
Next please.
We'll go next to Kevin Fischbeck with Bank of America. Please go ahead.
Great. I just wanted to understand a little bit better this year's guidance. You guys reported
a quarter which beat at least consensus numbers
by $0.15 but it looks like you're only raising guidance by $0.05 at the midpoint. So wanted to understand a little bit how you thought about guidance, if there's anything that you thought of in the back half of the year that might a headwind that maybe you weren't anticipating before that maybe the market wasn't anticipating?
I don't think so. And I might have Dave comment on it. But in essence, we tend to operate within a range and feel comfortable in that range. I think excessive precision here is time has taught us to be careful about that and to in essence be prudent with respect to the guidance that's offered. I would say that the performance of the business has been strong through the first half.
And while there is the orientation of the business was more challenging to the second half, we are pretty much on course and had saw no reason to do anything other than tighten to the range of guidance.
Right. So Kevin, it's Dave. If you kind of parse through this, the range of $5.35 to $5.50 per share suggests that the second half of the year will not only be stronger than the first half of this year, but also stronger than the comparative half year in 2012. And as you kind of commented on in the Q1, that's largely due to the change in the seasonal pattern of Part D revenue and profit recognition. While Steve had it right there, it's very modest pressure, additional pressure on the back half of the year.
I think we've already pointed some of these out. But just to keep in mind, obviously, the last half of the year has 2 quarters of the sequestration impact versus the first half of the year only having one as an example. And then of course as you also see we have an uptick in a run rate of our growth patterns in the business as well. That requires some investment not only in terms of selling, but also in terms of implementation. And then Steve did mention the near term impact on the higher interest rates than the impact that they have had on our ability to recognize the extent of capital gains that we have in the past.
And then the last thing I'd just point out is our tax rate will return to 36.75% level for Q3 and Q4, which will comparatively impact earnings in the last half of the year.
Okay. But I guess, except
for maybe higher interest rates, none of those sound necessarily new
like new headwinds per se? Yes.
I was just trying to give you some no,
I just think we're just trying to establish a prudent balance, I think consistent with what our posture has been for the last several years. And the businesses continue to perform well and Optum in particular is having a very, very strong year. But we didn't really see a need to change the guidance other than to tighten the range given the fact we only have a half year left.
Okay. Perfect. Thanks. And we'll go next to Josh Raskin with Barclays. Please go ahead.
Hi, thanks. Just taking a
look at the SG and A changes, it came a little bit higher than we were looking at. I think you were up 20 basis points. The ratio was up 20 bps in the Q1 and now up 90 in the second. And I see the TRICARE piece of it, but I'm just curious what's driving that? Was there sort of was there any discretionary spending, any acceleration of planned spending that you thought would be coming?
And maybe within that, if you could just give us a baseline to start with the TRICARE revenue contribution that would be helpful.
Sure. Dave, you want to respond to that? Sure. Hi, Josh. So the operating cost ratio was up 90 basis points year over year.
It was very much in line with our expectations for this quarter. We mentioned in the script that there's several things contributing to that ratio, predominantly related to business changes. As you know, we had one large funding conversion from risk to fee in the Q1 that obviously will continue to impact us throughout the year. We've also added a meal, which has a higher SG and A ratio. And obviously, we didn't have a meal in the Q2 of last year.
TRICARE, of course, fee based contract as well as continuing
cost of implementation through the Q2, again, not in
place last year. And of course, Optum is growing very quickly. And then of course most of that business is service oriented and fee based as well. The only thing I'd point out beyond that, which is all in the script really is there's continued cost of implementation for COPACA, ICD-ten, the TRICARE implementation and the PBM migration, those are all items that are inside our numbers for the 2nd quarter. And those for the most part associated with improved growth prospects for the business going forward.
So we're pleased to make those investments. The last thing I'll just say is that as indicated in the script is that obviously all these things have offset what this management team has done over the past several years, but in particular in the last year around cost containment efforts and done a very nice job advancing the productivity of the business and really meeting the impact of this mix shift on this operating cost ratio.
Got you. I was looking Dave more just 1Q increase versus 2Q increase. It looks like there was just sort of a pickup in the second quarter. I understand a lot of the implementation costs and the funding conversion in AMIL and the implementation costs. I know a lot of that was impacting Q1 as well.
So I was just curious what caused sort of the seventy basis point increase in sort of the year over year in 2Q? And trying to figure out if TRICARE was big enough to do that. My guess is as a fee based business, it probably wasn't big enough to cause that change.
Well, I don't think there's anything from our perspective that's out of line in there. I think it is the continued progression in mix. I think Optum continues to be a larger overall factor and I'm not sure everybody can actually calculate the impact of that, but I think that is probably the largest contributing factor that's a business that's all operating expenses and growing at a very solid rate. So I think it is as we have analyzed it, it is overwhelmingly mix. Even the items in terms of regulatory and so forth are basically in these numbers year over year and in them sequentially.
So there is nothing in that that we see out of line or outside our expectations or plans for the year other than probably an even higher level of performance on the part of our services business, which includes not just Optum, but also the significant growth in continued fee based businesses across United Healthcare. That's where all their commercial growth has been.
Okay, great. Thanks.
Hey, Josh, it's Jon Penshorn. Last November, we said 15.9% plus or minus 30 basis points. That range we affirm and that accommodates the accelerated growth in fee based services Steve referred to.
Okay. Thanks, Jim.
Jim. Next please.
We'll go next to Peter Costa with Wells Fargo. Please go ahead.
Hi, guys. Can you go over for us how OptumRx growth is helping the firm exactly? We can see it on OptumRx, but some of the improvement bleeds over into the commercial side of the business. What portion is on the commercial side of the business and what portion is on in OptumRx itself? And then can you talk about the growth path of OptumRx in 2014 2015?
Sure. I'll have Dirk respond to that. I mean it is perfectly in line with OptumRx's agenda on synchronization and the impact it had extending to the total medical costs. So Dirk, do you want to comment? Yes.
I think, well, let's start off by talking about the business. I think if you look, our RFP volume is up a bit year over year. And if you look at what we see, we don't see a lot of the business changing hands across the PBM space. But what we do see, we're actually getting a little more than our fair share and our retention has been pretty good. So if you look at what we try to do, we try to again manage total health outcomes as well as improving the cost of care.
And we do that. So we want to do with our synchronization approach where we bring all the data together and optimize the overall spend. So we think that in addition to our specialty offering in the marketplace is resonating very well. So that bleeds through performance for United Healthcare and its businesses and obviously for our government programs. So it does we think make us distinctive with respect to medical cost trends, with respect to that section of medical cost drugs, as well as a growing and vital and more diversified PBM business that we think the potential once this migration is fully digested and we can focus our full attention to the external marketplace, I think the growth prospects of that can be quite impressive.
Can you quantify for us in any way how much of the improving MLR on the commercial side comes from bringing the Optum business in house? I think that we would be it would be too much of back of the envelope kind of response. So we'll take that offline and we'll kind of bring that kind of thing perhaps back in the next in our next quarter, we'll comment specifically on the impact of that. I just don't want to shoot from the hip on something like that. So I think it's a very good question and I think we'll take it that way if that's okay with you.
That's fine. Thank you very much. Thank you.
And we'll go next to Sarah James with Wedbush. Please go ahead.
Thank you. There's obviously a robust conversation going on with parties in D. C. Around the sufficiency of 2014 Medicare rates and how that may influence 2015 budgets and rates. Can you give us a read on what you see as the current perception in DC of the adequacy of 2014 rate?
Initially, it seems like they viewed 2014 as more positive than you view it. So I wanted to see if the perception in DC has changed throughout your discussions with them. And if you could give us a read on the level of their receptivity compared to previous years to the information you're presenting on where rates should be going forward?
That is a that would be a challenging kind of conversation to have in a forum like this. I would say this in a very constructive way that access to the administration, CMS administration, HHS and so forth has always been open and fair and constructive dialogue and conversation. They obviously pursue a variety of protocols in establishing the rate process. It is a complicated process. It's multifaceted.
So it's not really possible to have a single conversation about elements such as that. I think our positions with respect to the funding patterns on Medicare Advantage are well articulated and supported. And there is an open dialogue about that and that dialogue is occurring in essence all year long. So I do think it's an environment where the parties are working together. I think there is a recognition of the role that Medicare Advantage plays in the marketplace.
And I would describe the conversations as very professional and productive. And I think we would have to leave it at that. It is not what I would characterize as some kind of contentious environment at all. These are extraordinarily professional people in the administration that are trying to administer these programs in the courts with the protocols that have been established and to the best of their capacities. And we are having an ongoing business dialogue with them on this subject.
So I think that's all we can really comment. And that happens in states as well in Medicaid. It's just the nature of the market.
Thank you.
And we'll go next to Ralph Giacobbe with Credit Suisse. Please go ahead.
Thanks. Good morning. First, just wanted to make sure I heard correct that you're planning on exiting 5% of MA markets next year? And if possible, if that's correct, can you give us a sense of what percentage of MA enrollment that represents today? And then second, separately, just wondering, has the delay in the employer mandate changed?
Or would you expect it to change discussion at all with employers? I guess it'd be helpful just to get a sense of how your discussions are going with employers? Is there more pushback? Is there confusion? Is there concern, etcetera?
Just trying to get a broad sense of the appetite to make changes due to ACA near term.
Thanks. Sure. Let's take Medicare first.
Hey, Ralph, Jack Larson. So the 5% is does relate to our membership and I really wouldn't call them market exits as much as planned withdrawals. So about 150,000 or so of our members will be impacted by member withdrawals. But in turn, about 80 plus percent of those members will have access to another UnitedHealthcare MA product.
Okay. That's helpful.
Hi, Ralph. This is Gail Boudreaux. There are a number of questions I think embedded around the employer mandate. So let me address that one first and see if I get to your issues. In terms of the first the delay of the employer mandate, we don't really think that that's going to have a significant impact.
Employers who currently offer insurance are going to continue to do that and that's been the course of our discussions. In terms of how our discussions are going with employers, there is a lot of change coming to that marketplace and the intense focus is around affordability. As I said earlier, not just on the exchanges, but across all of our customers, They're looking at value based plan designs, getting consumers much more engaged, how they integrate clinical programs. So I'd say the real focus is around affordability of coverage and improving consumer engagement and making sure they have real value for the dollars they spend.
Okay.
Thank you. Next please.
We'll go next to Cheryl Skolnick with CRT Capital Group. Please go ahead.
Good morning. The MA discussion is remarkably more bullish than I thought it would be and maybe is why your stock is trading up so nicely because it would suggest that 2014 may not be as challenged a year as one might have thought. So I guess the first question is, is that the first part of the question is that the correct interpretation that now that you've gone through all this, you reaffirmed your commitment to the program long term post-twenty 16, which I think was the point of that discussion, that you're able to find ways to mitigate the impact on both the beneficiary and the company of what is a dramatic underfunding of MA? And then the second question I have relates to capital deployment. Given that discussion about MA, can you either give us a sense of where you see the most attractive segments of your market or new opportunities be they international or existing opportunities like Optum, like commercial, etcetera, where you think are the highest best use of the capital that you're not already returning to shareholders?
Sure. First of all, and a very good observation, which I'd like to make sure we bring in line. I think our view in terms of Medicare Advantage is really not different than we had indicated last quarter. We believe that program is severely underfunded for 2014. The comments that we're making, if you parse them are that we are exiting certain markets, we're exiting certain plans, we're narrowing our networks across virtually all the markets, we are taking benefits down across all the markets.
So those are not good things for American seniors who engage on these benefits. And those elements will clearly put pressure on both top line for 2014 on Medicare Advantage, an important program for us and on the margins of that program. So to level set on that basis, that's I think what we said clearly.
I thought you said.
And we will work through those things and we are absolutely intense on this program because we think it has a meaningful long term value to American seniors and to basically the viability of the Medicare program in total going forward because it brings in market dynamics around managing medical costs, around engaging consumers, around holding care providers accountable, elements such as that. That's a long that plays to our competencies. It should be a strong long term market. So long as the program is funded appropriately. If it is not funded appropriately, then those market dynamics will change.
So I don't think anything has changed about that. We have just worked one more quarter through the tactics of how we will have to navigate through 2014. So to level set that, we are we see pressure in 2014 2015 on Medicare Advantage as a product. We're working through those. The program in our view has not been funded strongly in the past and 2014 was very significant.
It's a 7 50 basis points delta and what we see the cost of that program to be. In terms of allocating capital, we have a diversified model and that strategy of diversification is a conscious one with a notion of allocating capital opportunistically across spectrum of that diversified model. We see compelling opportunities and have in the Optum business. There are opportunities that will emerge we think in the benefits businesses and we think that they will emerge over time as more pressure is brought into the overall health benefits marketplace. And we look for opportunities where we can deploy our 3 competencies around local care, market engagement, around information and around enabling technology in international settings.
We found Brazil to be a compelling opportunity for that, particularly on our Optum Services side. There's probably more market opportunities for us on the international side and we'll continue to look for benefits. But that is going to be probably more opportunistic because we don't see as many of those other than in Optum. I think Optum has a significant opportunity on the international side. We parse our investments based upon cost of capital return thresholds along those lines and recognize our responsibilities in terms of returning capital pursuant to dividends and share repurchase.
So that's kind of the perspective and that really hasn't changed at all.
Right. So if I could just follow-up then, if I'm going to interpret your 2014 comments, I think what I would say is beyond the challenges provided by MA, you see your capital deployment and all the other expertise that you bring to the table as providing the kind of balance perhaps to 2014 offsetting some of the negatives in MA would be the continued pace that you see in the rest of the businesses. And that the challenge in predicting 2014 for us is to balance the negative of the MA against the positives of the other business. The Street is interpreting I think your comments as meaning flat 2014. And I'm trying to from my perspective, I think you said balance 1 against the other, but you didn't commit to flat.
Is that correct?
Yes. We have committed to no position on 2014. I think beyond that, that what you're laying out is broadly the way I would broadly correct and that is we are positive about the other aspects of our business and our capabilities and we are applying them intensively to the pressure that is being put on the Medicare Advantage program and are still working through that. So we haven't declared on 2014. We are focused on growing earnings in 2014 and growing this business that is our focus and our intensity every year.
We have a lot to offer in terms of our diversified business model. And when we feel we have worked through this to the point where we can responsibly offer some direction to the marketplace, we will do that. But I think generally you have the framework of it correct.
Thank you so much. I appreciate your indulgence.
We'll go next to Ana Gupte with Dowling and Partners. Please go ahead.
Yes. Thanks. Good morning. So a lot of questions on 2014. I'm just experience in 2014.
So on the Medicare side, in the experience in 2014. So on the Medicare side, in the Q1, you had quite a bit of deterioration in your ex commercial medical loss ratio. You brought up sequestration enhanced Part D and some seasonal patterns of 1st quarter pressure and so on. It seems to have eased up a lot in 2Q. I'm just trying to understand if it's because of Part D or you've actually done something to improve your base Medicare Advantage business and the potential margin deterioration that you've been experiencing I think in 1Q or is it prior period reserves or a mail or something else?
I think we'll have Dan comment on it. Clearly Part D is a factor in it, but I think it's not the only one. So Dan?
Sure. This is Dan. You had a lot in there. To Steve's point, absolutely, the biggest difference as you look sequentially, Q1 second both on a consolidated basis and in government programs and Medicare obviously is the Part D timing in the Q1. As you look year over year, it actually increased the loss ratio.
And as you look at the Q2, it actually decreased the loss ratio on a year over year basis. So that's the biggest swing item. But I'd also tell you inside of Medicare that we also have we have more favorable development than the Q1 and on a year over year basis and that's a little more concentrated in our Medicare business. And from the 1st to the second quarter in Medicare, we're seeing a little bit better performance on our new growth in Medicare. So those are some of the things that are influencing it with Part D being the most pronounced.
So year over year, your base Medicare business and if you can split out Medicare Advantage and Part D, do you expect deterioration from 2012 or not for the full year 2013?
On the full year, we expect our Medicare Advantage loss ratio to go up. Obviously, we have the significant reimbursement challenges as well as sequestration and then working against that as our focus on clinical management and so forth. So but yes, in aggregate, we expect our Medicare Advantage loss ratio to increase on the full year. As you look at Part D, our performance is strong there. On the full year, our earnings will be up and they're up in large part due to the significant volume growth that we had in Part D.
And obviously, the quarter to quarter progression is different. But in aggregate on the year Part D earnings are going to be up.
Thanks. That's helpful. Then just to follow-up on the commercial side. You had a little bit of margin expansion in 1Q. You had cited the loss of a big fully insured very high MLR account at the time.
You're seeing a little bit of margin expansion in the Q2. Your days in claims payable have gone up by a day. All of you are on the hook for this tax for next year. So should we expect that either your reserves will strengthen or that your commercial underwriting spread gets better through 3 and 4Q as you build up for that tax burden?
On the commercial side, yes, we had a decline in our loss ratio again this quarter on a year over year basis. We're down 10 basis points. A big portion of that is obviously the large case funding conversion that we had at the beginning of the year. And that's being offset by the competitive market environment. We guided at Investor Day to more than a 1 percentage point increase in our full year commercial loss ratio.
We've adjusted for that large funding conversion and we still expect at the midpoint about a 60 basis point increase in our commercial loss ratio on the full year. So full year commercial loss ratio guidance still in that 81.2 percent plus or minus 50 basis points.
So you're not
getting pricing. So you're not
getting pricing. The question
is really a baseline one, the commercial baseline for the current year is very solid, very strong. And it will then run into the challenges as you point out that everybody will run into the marketplace in 2014 2015. I think we have to move on. We'll take 2 more questions please.
We'll go next to Carl McDonald with Citigroup. Please go ahead.
Great. Thanks. Can you roughly quantify the margin compression that you're expecting to see in Medicare Advantage next year? So roughly, are we talking 50 to 100 basis points or something bigger than that? Yes.
Well, we first of all, we don't really get into margin at that level in the first place. And I think if I could do that at this point in time, we would have more to say about 2014. So that's what we're working through right now and we have to work through them on a real basis through the specific markets. So I really can't offer guidance at that level of precision in the mid year of the current year.
Yes. Maybe to ask it
a different way. If the headwind that you're talking about is 7.50 basis points, you talked about sort of the seniors' ability to handle adjustments to that. What would you view as being a reasonable amount that a senior could handle in terms of benefit design change in a given year? I have no basis to really speculate around that. Let me go back to a couple of things.
If you think about it, that spread that you're focusing on, we're attacking by in part taking benefits down in a way that maintains the value and viability of the program. And it is it runs a spectrum across markets. So it's not like a universal thing. This is done at a relatively precise level market by market. Network shaping is also that.
We have historically sponsored a very broad, very open access kind of market for our Medicare Advantage, we will be forced to narrow that. We are focused intensely on operating costs across the board. So those are the elements that we're really playing in. And obviously, we are as I said, we're operating in a way to maintain the long term viability of the program. But my second point in there was protecting margins.
The sustainability of the program has to be that it is one that returns capital. So we are protecting the margins of that program and that is a market by market proposition relative to our set of assets in the marketplace as well as the way the program is being administered by a sponsor in those markets. It's a complicated proposition, but I can assure you we are focused on closing as much of that gap as possible. And seniors are clearly going to participate in it, pursue the benefit reductions, narrower access. So none of these things, the underfunding of the program is not a good thing for American seniors who benefit from these programs.
But we are trying to navigate that in the best way possible to preserve this program's volatility long term because we think it has compelling long term growth aspects and value to the administration in terms of what it can do for Medicare. Next question please.
We'll go next to Christine Arnold with Cowen. Please go ahead.
Good morning. Thank you. Optum seems to be running generally ahead of expectations. Is there any change to the long term Optum objectives that you outlined at Investor Day? And you talked about international being a substantial opportunity.
Where else do you see these opportunities in Optum?
Perfect. Larry, you want to comment?
Sure. Hussein, it's Larry Renfro. And I think you know this, we put together a, what I'll call a multiyear business plan back about 18 months ago. We call that 1 Optum. And when we did that, we wanted to make Optum a more potent solutions organization and we wanted to really position ourselves for the future.
And at the same time, we made some financial commitments to you guys on the ROIC being 15% by 2015, the 6% operating margin by 2015 as well as doubling our operating profit of 2011. So those goals that we set at that point in time, we're kind of marching down the road. We're hitting those pretty well and meeting expectations and sometimes actually doing better. The initiatives around them are pretty much around simplification, reengineering, business integration, really the whole business alignment. And we talked a little bit about the PBM.
And in 2013, we have now started to pivot toward growth. And part of the growth initiative and I also get to part of your question is that we're trying to really have deeper what I'd call larger as well as significant relationships with our customers. And that's actually working fairly well for us right now as well. The other part of growth, we've been talking about this today, comes from what I'll call new opportunities that surround us around so let's just talk about Medicare rates and the pressure that's going on in the industry. So what all that does for us is cause us to really look for the future and we have to put certain development dollars as well as innovation dollars in to make all this work.
I would say that international would fall into that same category in terms of innovation and development as we work toward doing a lot of these programs that we're doing today in the United States, we'll be putting them into Brazil. So we're confident that we have planned investments. We're balancing those investments with growth as well as cost management. But at this point in time, we would pretty much stand by the overall multi year plan in terms of our guidance to meet or exceed the high end of the range.
Great. Thank you.
So thank you all. Once again, thank you for your interest in UnitedHealth Group today. We have had a very solid quarter and a strong year to date both for UnitedHealthcare and Optimum both continue to grow. Our performance trends are positive. I think it reflects in part the value of our diversified business approach and we remain intensely focused on the remainder of 2013 and on 20 14 and the long term success of the enterprise.
So thank you for joining us.