Good morning. I will be your conference facilitator today. Welcome to the UnitedHealth Group first 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's 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 the 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-K, dated April 18th, 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 the floor will be open 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. Thank you for joining us. Today we will review our strong start to 2013 and update you in broad terms on the environment we expect for the balance of this year and into 2014. As you can see from our release this morning, first quarter revenues grew more than 11% to reach $30.3 billion. We continue to grow market share and increase the number of customers and consumers we serve across every one of our businesses that make up the two core platforms of UnitedHealthcare and Optum. Our results reflect the consistent combination of fair and steady pricing disciplines, fresh innovation in our products and approaches, the capacity to address the changing needs of many of the key healthcare markets with comprehensive and integrated solutions, and the fundamental values of consistent, responsive, and compassionate service in everything we do.
These elements all play to the steady top-line growth we have been fortunate to realize this year and over the past three-plus years as UnitedHealthcare has added a net 5 million U.S. consumers, virtually all organically over that challenging economic period, and Optum has emerged as the distinctive enabling platform for advancing change across the healthcare system. First quarter net earnings were $1.16 per share and were driven in particular by stronger earnings from Optum. Cash flows from operations for the quarter of $1.1 billion represented 85% of net income, a nine percentage point improvement from the first quarter last year. Our balance sheet remains strong with $3 billion free cash and quarter-ending debt to capital ratio of 36%.
We repurchased more than one-half billion dollars in shares for the quarter, consistent with our annual plan, paid $216 million in dividends, a 29% increase year-over-year, our return on equity for the quarter was above 15%. Turning to UnitedHealthcare. In the commercial markets, we work closely with one of the largest fully insured customers in the nation to convert its coverage arrangements from risk to fee status. While the bottom line impact of this conversion is negligible, revenues are impacted significantly in this instance by $2.5 billion annually. Looking through this jumbo 1.1 million member conversion, our organic consumer growth is pacing ahead of our plan for the year, with first quarter commercial membership growing 375,000 overall, self-funded benefits up 480,000 people, risk-based benefits down a better than expected 105,000.
Commercial pricing yields are tracking well with our expectations, the commercial care ratio for UnitedHealthcare came in at a solid 78.3% for the quarter. We are lowering our full year commercial medical care ratio target by 80 basis points from 82% to 81.2%, ±50 basis points, in large part to reflect the large case funding conversion. Growth across our Medicare offerings was even stronger. We added a net 300,000 seniors to Medicare Advantage, 145,000 to Medicare supplemental benefits, 485,000 to standalone Part D drug benefits.
As expected, Medicare and retirement margins were down in the first quarter, given the Medicare ACA rate reductions, the shift of our traditional level of first quarter Part D profits to later in the year with the introduction of our enhanced plan design, the strong level of new growth in Medicare Advantage, significantly from unusually high levels of reserve development in the first quarter of 2012, which we were never expected to repeat in 2013. Sequestration will now add further margin pressure over the balance of the year. In Medicaid, we grew a net 65,000 people, representing organic growth of 125,000, offset by a divestiture impacting 60,000 beneficiaries, and we see no end to the growth opportunities. We've been privileged to expand services in Arizona, New Mexico, Nevada, and Florida.
We look forward to the significant opportunities to grow and serve additional states and to seek further in-state expansions as the Medicaid proposal pipeline remains robust. Lastly, we are pleased with the very strong growth of more than 200,000 commercial lives at Amil in the first quarter. In all of these broad categories, commercial, Medicare, Part D, Medicaid, and international, we are trending to the high end or above our growth outlook for 2013. Looking at UnitedHealthcare on an all-in basis, the first quarter operating margin of 5.8% was well within the range of our expectations. As we also expected, reserve development levels of $280 million for the quarter were sharply less than the unusually high $530 million in development in the first quarter of 2012. The first quarter of 2012 also benefited from a care ratio rebate true-up of $130 million.
First quarter of 2013 saw greater positive development in the commercial business than in the government-sponsored program. Overall, our cost estimates are proving to be quite accurate. Operating cost management across UnitedHealthcare continues to be a strength, even as we continue to spend to meet the extensive requirements of the new healthcare regulations. Turning to Optum, the growth pace accelerates further. First quarter earnings from operations nearly doubled. Revenues were $8.4 billion for the quarter, a nearly 15% year-over-year top-line growth performance. Every Optum segment grew organically and benefited from the continuing efforts to integrate and simplify the organization, focus on the customer, and pivot to growth. Revenue growth was exceptional, with Optum Health growing revenues 26% to $2.4 billion, Optum Insight growing 15% to revenues of $773 million, and OptumRx growing 10% to revenues of $5.2 billion.
For Optum, margin restoration and expansion was an area of intense focus in 2012, and it remains so. The progress has been impressive, with Optum's operating margin at 5.9% for the quarter, compared to 3.4% for the prior year quarter, and with each of Optum's businesses meaningfully strengthening its margins. Optum Health doubled its margins from 4.7% to 9.3% for the quarter. Optum Insight advanced from 13.3% to 19.3% first quarter margin, and OptumRx expanded from 1.5% to a 2.3% margin, even with continuing costs associated with the significant current year insourcing efforts. The market needs and is looking for the enabling capabilities Optum offers. We anticipate further client developments in coming quarters will illustrate just how strongly Optum is maturing, holding its focus on execution and customer service, and pivoting to growth.
As we assess our position and our outlook now informed by the events and perspectives of the first quarter, we remain in a strong overall position with our unique diversified businesses growing and performing well. That's in large part because we are serving customers well, we're steadily advancing our agenda of value in innovation, and strengthening and readying our businesses to both navigate the coming market changes and then maximize the market opportunities with the right timing. As we move beyond the successful TRICARE implementations and migrations of more than 12 million consumers to the OptumRx platform, we will redeploy energies and resources to advance new areas. The early themes of these new areas have been discussed with you before.
They include the comprehensive new basics services model, a deep and substantive commitment to the rising importance of the consumer in healthcare, repeatable innovation disciplines and capability, deeper service and experience integration using simpler enabling technologies, and the acceleration of One Optum. The businesses themselves are positioned to grow and perform well in service to their markets. UnitedHealthcare businesses are growing well across the board. Customer retention remains strong, and the new military and veterans platform is in place and operational. 2.9 million people from military families joined us on April 1st. In relation to the exchange markets that will begin in 2014, our views from last quarter remain unchanged. We will be very selective in where we participate and do not believe the exchanges will be a significant factor for us, either plus or minus, in our 2014 commercial market outlook.
Amil is off to a strong beginning with its seasonally strong first quarter and has the potential to exceed its earnings plan for the year. We see this market and Amil's market-leading offerings well-positioned to grow and diversify in the traditions of both Amil and UnitedHealth Group. Optum's momentum in growth and margin expansion should accelerate as it becomes increasingly capable and mature. Optum is now tracking to reach or exceed the upper end of its earnings outlook for 2013 and is establishing its own reputation for fundamental execution, service, and innovation. While we are performing well, we are doing so in a challenging economic, regulatory, and healthcare climate. The headwinds we have discussed in our past sessions with you remain very real. By far, the most impactful headwind is the Medicare Advantage rate picture for 2014.
While the final guidance was improved from the negative 8% all-in starting point, it is still a significant challenge. The cumulative net effect of the SGR resolution, the mandated ACA rate reductions, the strong negative impact of the risk recalibrations, and the insurance tax still leaves the Medicare Advantage program significantly underfunded. A more than 4% net reduction against a typical industry forward medical cost trend outlook of 3% or more for 2014. These rates will undoubtedly impact the more than 14 million Medicare Advantage beneficiaries across the nation and will cause UnitedHealthcare to reduce benefits and pull back access in certain markets, and will affect the growth prospects and earnings potential for our overall Medicare Advantage offerings across all our markets for 2014.
We did not expect the fastest-growing, most popular, and most effective of the Medicare benefit options serving America's seniors would be underfunded to this extent in 2014, particularly with the backdrop of the already existing ACA mandates and sequestration. We will take the time to fairly assess the implications to our 2014 UnitedHealth Group growth outlook and whether our growth expectations for 2014 can be sustained in light of the continuation of both sequestration and a significantly greater rate setback than anyone could have expected. Coming back to 2013, our original outlook did not factor in sequestration, which began on April 1st. It has the potential to burden us in a range of $250 million-$300 million over the balance of 2013.
We plan to absorb that within our $5.25-$5.50 per share earnings outlook range for this year, which keeps us oriented to the midpoint of that range for now. As always, we are committed to delivering to the absolute best of our abilities for you. Our balance sheet is strong. Our cash flows from operations are expected in the range of $7.2 billion-$7.6 billion this year. We have already targeted returning up to $4 billion of that to shareholders through dividends and share repurchase. We expect the general narrative of UnitedHealth Group's story for 2014 to be largely the same as 2013. Our commercial benefit businesses, international businesses, Medicaid and military businesses should all continue to perform well. Medicare will likely experience market exits as well as in-market membership contraction as we reshape Medicare networks and benefits to respond to the continuing underfunding of this program.
We will continue to manage operating costs and improve both service and productivity for this program. Optum will continue to grow and contribute more to our overall performance as virtually every Optum business and product line is growing and performing well and is expected to continue in that path. We remain optimistic about the capacity and capability of our enterprise to serve society and to create the value for the people and customers we serve, as well as for the health system at large. Despite the great attention paid to rules, regulations, and political maneuvering in healthcare, we keep sight of the fact that healthcare is about people, patients, individual consumers, physicians, and other care professionals.
If people are served well with appropriate quality care, provided in a respectful and compassionate manner at a cost that's reasonable, and if the professionals who provide that healthcare are treated respectfully, then our healthcare system and our enterprise will move forward. UnitedHealth Group has been built as a living, evolving set of businesses focused on working, serving, and innovating on behalf of the people we serve in the communities where they live, putting capital to work to create a distinctive return to investors while simultaneously advancing the healthcare system for a distinctive and constructive return to society. Our strategy, market positions, and consistent execution for customers differentiate us, we'll be happy to take your questions this morning. As always, please limit your questions to one person. Thank you.
The floor is now open for questions. At this time, if you have a question or comment, please press star one on your touch-tone phone. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. We ask those with questions to limit to one question per person so we can get to as many participants as possible. We request that you do not utilize a speakerphone or headset when asking a question. We'll take our first question from Ralph Giacobbe with Credit Suisse. Please go ahead.
Thanks. Good morning. Just wanted to go back to the conversion. Maybe you can help us size the headwind from an earnings standpoint. Then, are there many more accounts this large that are still risk-based? Any comment on incremental appetite to shift ahead of 2014? Thanks.
Yeah. The impact, as we said, was really negligible. Jeff Alter can really take you through this.
Yeah, I think it's important to keep in mind that this was a very unique case, a $1.1 million fully insured case. I think it's probably the largest fully insured case in the industry. It was fully insured for decades. We've been partners with this municipality for a very long time, really because of regulatory constraints. The conversion shouldn't be seen as anything, just playing out a decade-long process of putting this case into a self-funded condition where most cases this size have always been. There aren't any. As you can imagine, a case this size, there really isn't any earnings headwind. It was a long almost 40-year relationship with this client, the earnings are stable. It's really just a plain funding conversion.
What about on the smaller side?
Yeah. Hi, this is Gail Boudreaux. Just to follow Jeff Alter's comments to the second part of your question. Overall, actually, our conversions to self-funded have been relatively consistent. There's been a long-standing movement from fully insured to self-funded, but we have not seen any acceleration in that, to your earlier question. It's been pretty stable.
Okay, thank you.
Next question, please.
We'll take our next question from Sarah James with Wedbush. Please go ahead.
Thank you. Can you speak broadly about 2014 headwinds and tailwinds? I'm interested here in the growth in some of the unique businesses that United has, such as Optum and Amil, but also in the core U.S. risk businesses, particularly given the incremental information that you've received since the last time we spoke on changes to the risk coding, calibration, and county rebasing for Medicare and provider contracting for exchanges with better clarity now on the unit cost basis you'll be using.
Sure. I think we'll parse these a little bit between Optum and UnitedHealthcare. I'll start out with Optum, and I think our focus in UnitedHealthcare really will be around, we will be restating comments we made from our formal commentary about exchanges and Medicare. I think really Medicare is the principal headwind on 2014. The rest of it, I think we were trying to make it clear that our businesses are very strong and our growth is very strong, including Medicare. Larry, do you want to start with Optum?
Sure. Sarah, it's Larry Renfro. I think you're probably aware of the three-year business plan that we put together last year. We call it One Optum. As we finished 2012, we were in a situation of pretty good momentum that has carried forward in the first quarter. I think also what we're experiencing with what's going on with rate cuts, there is obviously increased pressure in the market. As a result, Optum is actually having a lot of opportunities that's presenting itself to us. What I'm going to do, I'm going to ask three people. I'm going to start with Bill Miller and go to Stan Dennis and then to Kathy Hopkins to talk about their individual businesses within Optum, so you'll get a better flavor for everything.
Thanks, Larry. Thanks, Sarah. This is Bill Miller. I would say on the behalf of Optum Insight, Larry's right that a lot of the growth certainly is expected based on all the work that we did in 2012, sort of establishing some sustainable new levels of performance. Alongside of that, and particularly in Q1, these pressures that Larry spoke about have showed up in Insight in two pretty simple ways that one, in our payer market and provider market. If anything that our businesses do around operational performance, quality, and efficiency, anything where our clients are feeling those pressures, those are opportunities that often flow to Optum. That's true in our payer market around things like payment integrity. In our provider market, it often shows up in some of our efficiency businesses and revenue cycle businesses.
The other thing I would stress that have been key areas of the growth as this environment with higher compliance requirements, particularly in our provider business. We're seeing the uptake of all of our compliance businesses pretty dramatically over 2012 but also going into 2013, and we expect that trend to continue as the heightened awareness about compliance is here to stay. That's where I would categorize our big growth areas. There are others, but those are two critical ones, and I think they're brought on by some of the environment that both Steve and Larry have discussed. Stan, go.
Thanks, Bill. Sarah, this is Stan Dennis. I'm going to comment on the physician businesses that are principally organized within collaborative care and specialty networks. I'm going to then hand it off to Kathy Hopkins, and she's going to talk about our consumer-facing businesses. We had a strong start to the year for this group. The Q1 performance is grounded in the solid plan that Larry referred to, created momentum coming into the quarter across all of our business units, and we remain committed to its execution. The results are driven principally by a healthy balance between growth and cost management disciplines. I can't point to one business that drove the results for the group as all the business units across the group are performing at the upper end of their range. Collaborative care asset has a broad and growing footprint with solid performance.
In a measured way, we are integrating these practices, which is part of our simplification plan. In doing so in a way that it adds value to improving care and affordability in the communities that we serve. We have several lines of business in our specialty networks division, all with strong performance. The performance of our military reserve readiness business was solid as well. We had a strong start to the quarter. We have our head down. We're going to continue to focus on executing on this plan, pivoting to growth, and as we do so, we believe these businesses will continue to scale nicely and perform well. Kathy?
Thank you, Stan. Good morning. This is Kathy Hopkins, and as Stan mentioned, I will speak to Optum's consumer-facing businesses. We're seeing strong demand for our care management, financial, and distribution services. As Larry mentioned, we're performing solidly against our three-year plan. We're enjoying the benefits of our cost management programs that we put in place in the last year and expect these benefits to carry forward. We're also enjoying the benefits of scale and simplification of many of our business lines. We remain focused on execution and continuing to further develop our products and services that help consumers as they choose their benefits, navigate the healthcare system, and make good decisions about their health.
These programs are being well-received in the marketplace. As Stan said, I don't think I can point to any one aspect of our business that contribute to be the driver, but we're really performing well across all aspects of our business.
Comment on Amil?
You might comment, I had Dirk coming.
Oh, sure. As from a PBM perspective, we had a nice growth year in over the last 12 months. We've grown a little over 1 million members. What I would say, our value proposition remains strong. We've talked about it before in New York. Really, it's all about optimizing health outcomes and minimizing costs, and we do that by using our clinical engines to bring together all the pharmacy, the lab, the medical data, the behavioral data to have appropriate interventions, again, to minimize costs and optimize health outcomes, and that value proposition continues to resonate within the marketplace.
Pretty positive across the board. Maybe Gail, you want to talk about UnitedHealthcare and maybe Dave at the end comment on Amil?
Sure. Morning, Sarah. Two questions I think you had embedded there. I'll focus on exchanges and Medicare. First, on the exchanges side, I think as Steve said in his opening comments, we don't see the exchanges on the commercial side having a significant positive or negative impact in 2014. We do think that there's still long-term growth opportunities in the exchanges, we're still positive over the long term. Overall, our position on exchanges hasn't changed, as we gave you a broad range at the last call. We think about the contracting side, again, I think I shared this last time that we see the contracting based on a market-by-market assessment and the economics needed to participate effectively in that market and in exchange. Those rates are going to vary from commercial to something less.
We've had a pretty long history of having value-based networks and have been successful at that. I would tell you at this stage, our contracting for the exchange markets is going very well, we feel positive about that. Turning to Medicare, that is the most impactful headwind that we face heading into 2014. Again, I think in Steve's opening comments, as we think about a 4%-plus rate impact, plus the impact of sequestration against a backdrop of a 3% trend in Medicare, that's an accumulated impact that is more significant than we would have expected. We're in the process right now of doing our bids. We're doing a market-by-market assessment of what those imply by each of our markets. Again, this is part of the accumulated underfunding, we do feel we have a very strong Medicare business.
As part of that assessment, we will be using our clinical assets and looking at optimizing our network to provide the broadest base support and consistent benefits for seniors, because that's been part of what we've been looking to do. That would, I think, define the headwind in terms of Medicare for 2014.
The rest of the business lines all strong?
Yeah, the other good point on that, the other businesses, I think as you saw in our growth this year, really positive about how our products and services are tracking. We're really pleased to have brought TRICARE on this year and feel very positively about the growth trajectory that we've seen, not only this year, but over the last several years.
Amil?
Sarah, it's David Wichmann on Amil. Thank you for your recognition of it. It's a very strongly positioned enterprise in Brazil. The brand, the value proposition from its own delivery components, its strong service reputation, and the value that they provide to the various communities inside Brazil is, I believe, unmatched. Coupled with that are the market dynamics, which are such that they support meaningful growth in that market, similar to what we're starting to see shape up here in 2013. A combination of those two things should provide a good avenue for both revenue and earnings growth in 2014 and beyond. As we step into 2014 and into the future, we also see the potential to access meaningful new markets in Brazil that are not or are underserved by Amil today. In addition, we see a great opportunity to address services offerings.
As you might expect, there are very little capabilities to the extent that we see with Optum, we see great opportunity for that enterprise in the future. Next question, please.
Thank you.
We'll take our next question from Christine Arnold with Cowen. Please go ahead.
Good morning. Thank you. Could you elaborate on two issues related to your commentary on 2014, the collectibility of the Medicaid premium tax, and when you're saying you don't expect the exchanges to impact your commercial business, are you including the potential impact of any margin compression in small group, and can you address that potential issue as well? Thanks.
Sure. Gail, do you want to discuss that and then maybe Steve Nelson can talk about Medicaid?
Sure. Let me start with the first question, which was around the tax on insurance, tax on Medicaid. We've been in a constant dialogue with our state Medicaid directors around the impact of the tax, and we are including that in our rate exhibits as we talk to them. It's recognized as a cost to the program. I think what's important there is, Medicaid is a little bit different than commercial in that our rate negotiations occur not just at a single point in time, but they're ongoing. They occur at the beginning of the cycle, throughout the cycle, and that's a pretty common occurrence. It's early in the process with them. We are including them again in the rate exhibits, and we think that there's been a positive dialogue about that.
In terms of the impact on exchanges, our assessment is that at this stage, just given the overall impact, not necessarily commenting on margins in small group, but our overall participation in the exchanges, we have a very robust product offering outside of the exchanges. As I mentioned, one of the tools that we're using are to build value-based products. We've seen most of our small group growth in those products already, we think we're very well-positioned, to also have a robust offering outside of the exchange.
Steve, do you want to add anything further?
Sure. Just one point that. Hi, it's Steve Nelson. I wanted to just add to Gail's comments. We have a very active and robust rate advocacy process, and iterates continuously with the states. As you know, it's a challenging rate environment. So far, as Gail mentioned, it's early in the year, but those conversations seem to be effective and very productive.
Am I hearing that you don't expect an impact on small group margins because you've got these value-based products and you think that you can convert people to them?
Yeah.
Yeah, I think that's right. Gail, do you want to?
Right. No, I think we have a whole portfolio of products, Christine, and I think we've always had a strategy of offering employers a multitude of options. That's been pretty consistent, at least over the last four or five years. While there are different pressures, clearly it's a very competitive market and small group. We work really hard to make sure that we put our clinical and network assets to work to offer employers a broad range. At this stage, we're not commenting on margins specifically there.
If you take a look at the growth that UnitedHealthcare has been able to achieve in the commercial markets, that has been in the newer products.
Right
that has been in the wide variety of products. I think that we've been deployed in this posture for a few years now.
Okay. Thank you.
Next question, please.
We'll take our next question from Matthew Borsch with Goldman Sachs. Please go ahead.
Yes. I apologize if you mentioned this earlier, are you prepared to reiterate your view of overall earnings growth for 2014? If you could, maybe a dovetail into that, what about Medicare Advantage enrollment? Directionally, can you say if you think that's going to be up or down, based on everything that's changing?
Well, I thought that in our prepared comments that we had addressed that, maybe I could restate a little bit for you, Matt.
Well, yeah. I'm sorry. I just missed it, you did. Okay.
It is. I'll be happy to touch on it. We were comfortable last quarter with the overall 2014 earnings growth outlook before the 2014 Medicare Advantage rate actions were taken. I think as you stand back and look at the basic overall funding in terms of MA, it has been pressured the last couple of years and is already absorbing ACA mandates, in terms of a rate reduction. If you believe that sequestration would come on top of that, you would never have expected a beginning point of an 8% net reduction in 2014 rates to occur. When the, basically, as that process cleared and some relief was provided, you still stand back and look at a net reduction of 4% or more against an overall 3% cost trend in the program.
Taken together with the other pressures, that's really not sustainable funding in our view, and it will cause us to reconsider our overall 2014 growth rate in this program to evaluate market exits, to address benefits, to reshape our networks in those markets. That was not really the premise as we basically leaned into 2014, from a growth outlook point of view. We are evaluating that at this point in time, given the finalization of those programs, really on a market-by-market basis, to the extent there are actions that we can take to mitigate this continued program and the underfunding, and assess whether 2014 can absorb that change and still grow earnings. Our long-term view on Medicare is unchanged. We're very strong in terms of the advocacy of the program. The underfunding has been a challenge.
We are reassessing net 2014 based upon the rate actions that were taken. That's why as we discussed in the previous question, that really our focus when you look at headwinds for 2014 is around Medicare.
Okay. I got it. Thank you very much.
Yep.
We'll take our next question from Justin Lake with J.P. Morgan. Please go ahead.
Thanks. Good morning. My question's on the government side. Two things. One, can you tell us how much the Part D seasonality impacted the quarter versus the typical that you'd previously seen because of that shift to the enhanced plan? You mentioned the pressure on Medicare margins due to rates. It's clear Medicare margins, what, they came down MLR up this year, going to do somewhat similar. You've got pressures in 2014. You've talked about a 3%-5% margin. Can you tell us how, are you there yet? Are you close to it? Do you expect to be there next year? Just to give us some idea on how to size that headwind going forward from Medicare.
Dan?
Good morning, Justin. Daniel Schumacher. Your first question with respect to the Part D timing and the implications of that on the quarter. As you look at it in the context of our overall UnitedHealth Group loss ratio, you can think of that in terms of about 50 to 100 basis points impact to our overall group loss ratio in the quarter. Basically, our revenue recognition is being shifted out later in the year, so it's a big impact in the first quarter, moderates in the second, and then it recovers in the third and the fourth quarter. With respect to the margin performance in our government programs, our target margin is in the 3%-5% range, and some years we perform in excess of that, and we are near that range now in our performance.
Overall, you feel like you're near that range now?
Yes.
If I could just slip one other in on the recalibration. Can you give us an idea of what you think that is? If I did the math right from what you said, you thought it was 8 before, now it's 4. You got 5% back from the SGR fix. You're saying you think that's about 100 basis point headwind from the risk score recalibration, the new model there? Do you think it's more or less than that?
I think it's more than that, Justin. Substantially more, which is why we're commenting on it.
Yeah.
Dan?
I think, Justin, as we look at the impact of that across the industry, we would size the recalibration more in the order of magnitude of around a 2.5% impact.
I would assume it's higher on maybe HMO plans that code better, have higher acuity. I've heard industry experts say it could be as much as 500 basis points for a real good IPA-based HMO versus maybe even less than 250 for a PPO that's maybe less well coded. Is that about right?
I'm not going to comment on specific product offerings. I will tell you're right, there is certainly variation as you look across products and geographies in terms of the impact of recalibration. Not likely the order of magnitude you're talking about.
Okay. Not as widespread. Great. Thank you very much.
Thank you. Good question. Next question, please.
We'll take our next question from A.J. Rice with UBS. Please go ahead.
Hi. Thanks, everyone. Just to take a minute to talk about the OptumRx situation. Have you sized the cost that you're incurring this year to transition that in-house? Does that spread evenly over the course of the year, and is there any early commentary on the selling season for them and what that looks like?
Well, I would say a couple things. First of all, how is the transition going? On the first of the year, 400,000 members converted. We actually also added 500,000 new members to the platform at the beginning of the year. On 4/1, we just added 2 million members, so we've migrated 3 million members so far. From a run rate standpoint, it'll be $200 million in operating profit at a run rate basis. We still have some ramp-up costs and development costs in 2013. We haven't specifically sized those externally yet, that's really where we sit.
You'll likely, that was Dirk McMahon, by the way, you'll likely carry those into the third quarter as you go through that, then they'll start to peel down in the fourth quarter and into 2014.
Yeah, that's the important point. We have development and ramp-up of personnel costs throughout the first half of the year, as Steve said, they'll peel down we'll hit our full run rate in 2014.
Okay, thanks. Any comment about the selling season so far? I know we're still a little early.
We've sold some cases already, of course. What I would say is our proposal volume is up. It is a little bit early. We've seen an increase in proposals over last year. I guess that's all I'll comment at this point.
Okay, thanks.
Next question, please.
We'll take our next question from Chris Rigg with Susquehanna. Please go ahead.
Good morning. Thanks for taking my question. I just wanted to come back to the revised commercial MLR guidance. Is the 80 basis points decline entirely due to the risk to ASO conversion? With regard to the quarter specifically, year-over-year, the MLR was down 40 basis points. We don't have the prior year development by segment. I'm just trying to get a sense for, one, in the change in guidance, is that all related to conversion? Two, what would the MLR have been without the conversion in the quarter? Thanks.
Chris, good morning. It's Daniel Schumacher. With respect to the commercial loss ratio and the impact of the funding conversion, it was around 80 basis points in the quarter and on the full year. That's why we've revised our full year medical care ratio guidance to 81.2% ±50 basis points, down 80 basis points from our Investor Day guidance. As you look at the influencing factors year-over-year in the commercial loss ratio, certainly that played a meaningful role in it. We also had the absence of leap year, which is more pronounced in the commercial business, and then pushing the other way would be the change in development as well as the large rebate true-up that we recognized in the first quarter of 2012. Those are some major impacts in the commercial loss ratio in the quarter.
Thanks.
Thank you. Next question.
Take our next question from David Windley with Jefferies. Please go ahead.
Thanks for taking the question. I wanted to stick with commercial loss ratio. The couple of hospitals have come out and talked about low volumes in the first quarter. Would you say that, lower than they expected anyway, would you say that they were more in line with what you expected? Is it too early to see enough development in the claims to reflect those low volumes in the first quarter?
Good morning, Dave. Daniel Schumacher again. As we look at our medical cost performance in the quarter, we were very pleased with it, and it paced out as we expected. As you look at both the composition of it from a unit cost and utilization perspective as well as the elements by cost category, we are not seeing any meaningful change in that from what we put out at Investor Day.
Your cost trend guidance in the buckets within that guidance are essentially unchanged. Do I understand that correctly?
Correct.
Okay. Thank you.
We really aren't necessarily standing on claims. We have good visibility with respect to particularly inpatient settings and so forth. Again, unchanged, but we're not sitting and waiting for claims data. That's the only thing I'd like to correct to that. Okay?
Okay.
Next question, please.
Our next question comes from Ana Gupte with Dowling & Partners. Please go ahead.
Yeah, thanks. Good morning. Coming to the quarter, you've talked a lot about the headwinds for the next year. I'm trying to get an understanding of what is your strategy for 2013 and 2014 on the share versus margin trade-off in 2013, and how that might play out into 2014.
I didn't hear this clearly. Could you just restate it again?
Yeah. The notion of the share versus margin trade-off between commercial versus the government businesses. You've expanded margins in commercial. I understand it's largely leap year and MLR true-up and all that, the surveys are showing that you and other companies are pricing up in commercial. You're certainly moving toward margin over share. If you look at Medicare, on the other hand, Part D, you came out with a $15 product on Part D. You've had outsized share gains in Part D, outsized share gains in MA. What is your target margin, and why should it be 3%-5% in Medicare when with an 85% MLR and the MLR floor reg, you can do better than that at a 10% SG&A?
Well, that's a very good question, but I also would maybe level set this a little bit, that we try to keep our pricing and our approaches to the marketplace in a consistent, stable approach year to year. Pricing essentially to our cost, trying to innovate and advance a variety of products to meet the different needs of the marketplace. We are out to optimize the performance of our business and the performance of our margins, no matter what the circumstances are in the context of maintaining sustainable products and sustainable offerings in the marketplace. I agree with your point that we should be able to get above target margins at full scale and at full operating performance in mature markets.
I think in many respects, we do that both in the commercial and Medicare sectors. Now after that kind of commercial announcement, I'll hand this over to Gail and Jeff and so forth to respond to the pricing. Jeff?
Ana, good morning. It's Jeff Alter. I think Steve's said it well. We have had a very long philosophy around commercial pricing, which is we price to our forward cost trend, and really don't play too many games around that. That has served us well over the years, we believe it will continue to serve us well, and maybe even serve us in a much better way as we get into the 2014 and 2015 timeframe. I don't think we really are discussing a trade-off. We have a disciplined pricing methodology that has served us well, and we continue to employ that as we go forward.
While we always have to pay attention to it, the fact is we've had very steady, consistent growth in both self-funded and actually on a relative basis, market share gains in the risk base because of the level of contraction in that marketplace and maintaining margins. Then on the Medicare side?
Well, I think we shared, I mean, the issue on Medicare, as we shared on this call, is really the underfunding of the program, and we work very hard on both the clinical side as well as the network optimization. Finally, our cost structure, that's been an area of focus. As I think about all of our government programs and our target margins there, we work to be extremely efficient while improving service so the operating cost is a lever, our clinical programs are important, too, to delivering value to the beneficiaries.
I'd just throw in that basically these are very well-established, well-penetrated programs in the marketplace, almost 30% market share in Medicare Advantage. The underfunding pressure is really more intense in the Medicare Advantage product line. It's not like Medicare across the board. Supplemental offerings, Part D offerings are really different. It's the overall funding philosophies of the Medicare Advantage platform that need to be strengthened.
Just one quick follow-up on that. On MA, as you're doing your product bids, which need to be submitted in June, and all this underfunding you're alluding to in 2014, should we expect that you will be, as we're modeling out 2014, that your margins will get better because you bid more conservatively at the expense of enrollment growth? Will it go the other way in that, in your optimization, you're willing to gain share and keep losing margin?
Maybe I'll start out by saying, first of all, it's like anything in healthcare, it's a market-by-market proposition, which is why we need to be very thoughtful about how we go forward in this. In some markets, we'll take actions that will be more conservative and more pulling back. In other markets, we may not feel necessary to do that. It also brings in dynamics of network positioning, and so forth. It is a much more multifaceted than simply what our benefit will be in a particular market. I think that's why it takes time, and there isn't kind of a single-gear response to your question that we'll price like X and calculate market share.
Although I would say that based upon the funding level, and we've been clear, we will be pulling back from markets, we don't expect the growth in the MA product line in 2014 to be as robust because of the actions we're going to have to take to, as your point, preserve margin.
Thanks. That's helpful.
We'll go next to Scott Fidel with Deutsche Bank. Please go ahead.
Thanks. I just wanted to stick on MA, and just interested if you can talk a little bit about utilization trends observed so far in the new membership that you've added so far this year relative to the more mature MA membership that you already have. Then maybe just touch on the lives that you've added in California, particularly relative to some of the PPO products that members were previously enrolled in with competitors, and how you're seeing the utilization trends in those members.
Dan or Jack?
Sure. Good morning, Scott. Daniel Schumacher. With respect to our utilization in MA, I will tell you that it's pacing about as we expected. Certainly, our new growth tends to have a higher first-year loss ratio, and that improves in the second year. That improvement comes on the maturation of the revenue as we get more complete diagnoses, as well as our clinical programs begin to take hold and those results begin to emerge. From a utilization perspective, it's pacing as we expected, but obviously our new growth comes with a higher loss ratio.
Yeah. I would say, Scott, Jack Larson, good morning. The overall portfolio or profile, I guess, of the new membership we got was very much in keeping with our expectations. As you pointed out in your question, it's only been two months really of development with these new members. So far, I don't think we're seeing anything unanticipated.
Okay. Just as a quick follow-up, just interested if you can maybe give us some initial comments just on the CalPERS contract that were announced, and then maybe just talk about some of the changes that CalPERS might have made with the new structures that make you more comfortable about participating in CalPERS risk business, given that historically when the public plans had participated, it used to be a pretty volatile book of business. Thanks.
Morning. It's Jeff Alter. It's really hard for us to comment on CalPERS right now, we're pleased. We thought we had a very strong offering for that RFP. We're pleased that we were selected as one of the four, and we're actually in the second phase right now of negotiations, very hard for us to comment on that.
Thank you.
John Penshorn here. If we could please sustain to one question. I don't think we're going to be able to get everybody in, I really would like to get as many people able to address questions as possible.
We'll take our next question from Carl McDonald with Citigroup. Please go ahead.
Great. Thank you. I was hoping you'd walk through the mechanics of sequestration, touching specifically on how much you're assuming you're going to be able to pass through providers in the hit you're talking about, and how long you think it will take to fully offset the impacts. In other words, on that last piece you're getting to, if it's going to be as big of an impact in 2014 as you think it's going to be in 2013?
Sure.
Sure. Hi, Carl, it's Gail Boudreaux. As you know, sequestration results in a lower reimbursement of 2% to our Medicare Advantage and Part D program. We've shared this before. We have some natural hedges to that, and Steve's opening comments, we talked about the impact. Our goal, what we're going to be doing is we'll be offsetting our reimbursement where our payments are tied and indexed to fee-for-service Medicare, that will be offset, and then our lower payments to capitated providers. Those that are not as tied to that, we'll be working obviously to manage through that as part of the overall program. Obviously given the time to implement, that's why we've identified the $250 million-$300 million impact in 2013.
Some programs don't have any, like Part D and so forth.
Part D doesn't have any in there. That's part of the issue.
We'll get more absorption as this goes on. We'll get this more absorbed into the marketplace. The impact
Going forward, we should dissipate. Next question, please.
We'll take our next question from Josh Raskin with Barclays. Please go ahead.
Yeah. Hi, thanks. I don't want to belabor all the other points, so I guess just a question on the repurchases. I know we'll see it in the Q, but could you give us an update on maybe the monthly repurchase numbers and maybe more specifically, how much was done after February 15th?
Hi, Josh, it's Dave.
This may be the first question we've ever been asked on monthly repurchase activity.
It was an important quarter, I think.
Okay.
Well, we repurchased about 9.9 million shares in the quarter. As you would expect, our mechanisms are such that we repurchase more when the stock price is down. As it tailed off, our repurchase activity accelerated. I won't get into the specifics about what we purchased in the last half of February or through March.
We're methodical.
We're very methodical about what we do. Certainly as our stock price goes down, we're more heavily into the market.
Got you. You guys have discretion on that, right? Based on your corporate outlook and things like that. That's just not a mechanical calculation based on the stock prices.
That's right. We do have discretion with respect to that. As you recall, Josh, given the Amil transaction, we were trying to meter to bring in [a set of our net plus equity] at 35% by the end of the second quarter of the year. We said we'd do $2.5 billion-$3 billion of share repurchases. We're edging up towards the upper end of that range for this year. That obviously mathematically would increase our repurchase activity for the balance of the year.
We are on plan, and we are at the levels that we would've anticipated for the quarter. We are regular and methodical in the marketplace. I would say what changes is the pace of it. We pace it in terms of that. We are basically at this on a regular basis. This is a methodical program. The pacing of it changes.
Okay.
That's all.
Perfect. Thanks.
We'll take our next question from Michael Baker with Raymond James. Please go ahead.
Yeah. I know you commented on the exchanges. I was just wondering in terms of that, as you continue to evaluate them, how much of a factor is it as it relates to some states now considering taking the Medicaid expansion and running through the exchanges? Is that a factor for you guys or really not meaningful in light of the broader picture?
Maybe I'll have Steve Nelson comment on this, but what the beauty of our diversified model is that we basically cover all the markets. We've said actually probably as much as 2 years ago when it became clear that this kind of a marketplace channel would become established, that we really are covered on both sides from the Medicaid side and the commercial side.
Sure, Michael, Steve Nelson. Yeah. States are evaluating a lot of different alternatives. They're struggling with how to cover their uninsured, bring down the cost of the Medicaid program. Exchange is one alternative that they're considering alongside of a variety of things, and we're very engaged in those conversations with the states and bring a lot of capabilities. The advantage is, as Steve mentioned, we have broad capabilities, not just in the Medicaid program, but across all of our products. The exchange decision and conversation is one that is outside of just Medicaid or commercial. Let me just ask Jeff to comment on the exchange strategy. With respect to Nevada, I think is one in particular that has required us to participate in exchange as part of our Medicaid contract.
Sure. Morning. It's Jeff Alter. As we've said in the past, we're going to gauge our participation based upon how we assess each one of those local markets. I would say that a part of that assessment is our commercial teams working very closely with our Medicaid teams, coming up with the value proposition for not just one or the other, but for both. That is part of our decision-making process as we pace through market-by-market decisions. I will reiterate though, that as we've said in the past, we believe that there's going to be some pacing with exchanges, and it's not just the 14 event. It is a market that will develop and mature and be part of the distribution of small business as well as covering individuals and perhaps in some states and some markets, Medicaid population.
As that market develops, we'll make those decisions together.
Thanks.
Next question, please.
We'll go next to Sheryl Skolnick with CRT Capital Group. Please go ahead.
Thank you very much for continuing the call to let me in. I'll try to be quick with this question. One of the things that I think the market's focused on, and appropriately as you have is the issues around MA. Some of the commentary, and I think some of the concern we're seeing is a perception that MA is the single either largest or only growth driver in the business. Perhaps you can help us to put this in the appropriate perspective and view it with the appropriate level of concern, which is it one component of growth? Is it the only component of growth?
Can you parse out the growth for us that you're seeing, if not in 2014, then a year like 2012 or 2013, to help guide us in our thinking about the potential impact of changes in MA versus the performance of the rest of the business?
I think we tried to suggest that the performance of the rest of the businesses is really quite strong, that the Optum businesses not only exceeded expectations for the quarter, the momentum is growing there, and it wasn't in isolated Optum businesses, it was across the entire expanse of that portfolio of businesses and offerings. We see them as a meaningful growth element and an increasingly growth element for us in 2014 and beyond. That is really unchanged. I think what we have been pleased with is how rapidly this has gotten traction and the substance of it, how solid the business is maturing.
The Amil business is another platform that we think has significant potential, and where we would be looking to continue to align our combined capabilities and potentially continue to invest to build that to be an even more meaningful platform going forward, 2014 and the years to come. In the UnitedHealthcare businesses, just take a look at the growth, which is why we came back to the 5 million over the last 3 years, and the broad base of it. Growth in every single offering. Meaningful growth. We think market share gains across each of them, and it's not just a current year phenomenon. This is 3 years or more. That doesn't even include the 3 million that we'll be reporting next quarter on the TRICARE business.
The focus is to optimize those businesses across their expanse, and that was the whole purpose of the diversified business model in the first place. Medicare is one that is getting more than its share of attention because of the funding posture that it's experiencing, and that one is really pretty focused to Medicare Advantage. We will work through that as well. It is just a more severe funding posture than we would have anticipated, given all the elements that have hit the Medicare Advantage program over the last year or so. Does that put it into perspective?
It does. I guess what I was kind of hoping for was something more quantitative than that, which might help us think through how much might be at risk, but I don't suppose I'm going to get that, am I?
Well, I think if you were going to get it, I would carefully put it in the prepared comments. What I did carefully put in there is that we are assessing this very seriously in terms of evaluating to what extent we can overcome the headwinds of Medicare Advantage with all the other elements of our business and produce growth in 2014, and that's our goal.
Excellent. Thanks very much.
Next question, please.
Next we have Kevin Fischbeck with Bank of America. Please go ahead.
Great, thanks. I want to stay on this MA side of things because I'm still a bit confused on a couple of points here. I think it really comes down maybe to expectations. It sounds like, versus what we were expecting anyway, the MA MLR was disappointing. When you talk about it, the things that you highlight as far as lack of development, as far as Part D seasonality, as far as PPACA cuts, it sounds like all those things you actually highlighted last quarter. They were all known things. Did you think that Q1 was in line as far as you feel on the MA side of things? Maybe this is just a perception side from our side of it? Was Q1 a little bit weaker than you thought on MA particularly?
2, the comments about 2014, although I understand the rate for 2014 is not a good rate, it is more or less what I think everyone thought it would be back in January. Obviously, we got hit with a worse proposal. It got fixed back, I think, to where we all thought it was going to be. I'm really trying to understand why the tone has changed so much from the view about 2014 growing, when to me, really the only thing that's changed in the MA reg is really the coding adjustments.
If the coding adjustment is really that big of an issue as far as being the unexpected part of the final rule versus where we were before to cause you to say, "Yeah, MA, we're not going to be able to grow it, and maybe our whole earnings number is at risk for 2014.
That's quite an involved question. Let me see if I can provide a simpler response and answer. We're very happy with our MA business. We have very good growth. We have very good products. We have great positioning in the marketplace. It is perhaps affected by contrast to the prior year quarter, where we had meaningful reserve development and never anticipated we didn't anticipate it in the first quarter of 2012 to have that level of reserve development. We certainly didn't expect it to repeat in the first quarter here. I think the health of our MA business is quite robust.
Our concern is the forward-looking. That may be an expectation issue because when you take a look at all the elements that have hit the funding experience of the MA program, I think the very significant factor was In lieu of that background, starting out with a negative 8% and then basically coming out with a final, which is, in essence, a relatively negative 4%, maybe even a touch higher against a 3% overall trend. Strikingly higher than, the year before was a 1.5% in that zone. That would've been more manageable. It is really overcoming that funding posture going forward that then begins to cascade through a variety of things. To respond to that, you need to think about benefit adjustments that are more dramatic than what we have typically liked to manage in the marketplace. Network adjustments that are more dramatic.
I think the difference is, I know that some people were relieved that the SGR came through and that focus on that element, when you stand back and look at the total funding status of that program, it's a down 4%. That is significant.
That's not what you were. Because down 4% is what we were kind of assuming the number would be if you throw all in. You were saying that when you made that comment before, you were thinking maybe similar to where it's been the last couple of years, which is maybe down 1.5%.
You are thinking of supporting the program. If you think about that as perhaps the best offering in Medicare in the marketplace, the one that seniors have high satisfaction with and strong growth and strong response, and one that manages cost. The posturing of funding that is what we're discussing.
All right, great. Thanks.
I think it is an expectation gap.
We'll take our next question from Stephen Halper with Lazard Capital. Please go ahead.
As you look at the development of the state exchanges, understanding that you're being very deliberate in pursuing those opportunities, can you sort of update us on where you think the whole program stands? I know it's a general question, but more specifically, the federal government looks like they're under increasing pressure to get this thing done, and do you foresee any scenarios where the administration has to back off and say, "We need another six months or a year to get this done," and just your views on that?
We really don't have any insight on that. We are presuming that these programs and these capabilities will go into market as scheduled. That has been the posture throughout, and we are acting to be ready to respond to those. We are not seeing or believing or suggesting anything to the contrary.
Thanks.
We're presuming that it is going forward as planned and as scheduled.
Great. Thank you.
Maybe a last question, please.
We'll take our last question from Peter Costa with Wells Fargo. Please go ahead.
Thanks. Most of my questions have been asked and answered. Can you just go over the operating cash flow? It was fairly weak in the quarter. What do you expect that to reverse itself in the second quarter, and what exactly caused the weakness this quarter?
Dave?
Hey, Peter. It's David Wichmann. Thanks for your question. The operating cash flows were actually stronger this quarter than they were in the comparative quarter last year. They came in line exactly as we expected. The cash flows at UnitedHealth Group at least are seasonally down in the first and second quarters, and they are stronger in the third and the fourth. The things that really affect that are the timing of our risk adjustment payments, which generally come in the third, and also the Part D timing, as an example. We expect to follow pretty much a pattern similar to last year. Operating cash flows for the year should be in the range of $7.2 billion-$7.6 billion, which is a 1.3 times or more times net income.
This is John Penshorn. Dave, I think last year we also had some timing differences around some of those government receivables in the second quarter that came in early. It may even be a little more second half biased. Is that fair?
That's right.
Okay. You didn't change the guidance on your consolidated Medical Loss Ratio. I assume that's really just the offset of the sequestration versus the commercial account conversion. Is that correct?
That's right, Peter.
Okay. You talked about recalibration being 250 basis points. Was that over two years or was that over one year?
No, that's one year. That's your three-part, one question limit, Peter. Thank you very much.
Thank you.
Wrapping up our call today, I'd like to recap just a couple points. Our enterprise is performing well. In the first quarter, we delivered significant growth in people served, in market share, in revenue across all of our businesses and internationally. UnitedHealthcare's commercial benefits, Medicare, Medicaid, military businesses, as well as Amil, all continue to diversify and steadily grow. Optum's momentum is accelerating as the market for health services expands, and it's expanding, we think, at kind of exponential levels. We believe no other company has the positioning, the resources, the people to take on the challenges of healthcare and succeed in this marketplace and in our mission. Thank you very much for joining us today. We'll see you next quarter.
This does conclude today's conference.