Good morning. I will be your conference operator today. Welcome to the UnitedHealth Group Third Quarter 2012 Earnings Conference Call. A question and answer session will follow UnitedHealth Group's prepared remarks. As a reminder, this call is being recorded.
Is 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 ks dated October 16, 2012, 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 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. Please go ahead.
Good morning and thank you for joining us today to review our 3rd quarter results. 3rd quarter revenues were $27,300,000,000 increasing 8% year over year again this quarter. Earnings grew 28 percent to $1.50 per share benefiting from strong revenue growth and improved operating margins. Our Q3 2012 operating margin of 9.6% reflects strong performance on clinical affordability and favorable reserve development resulting in a consolidated medical care ratio of 79%. Sharp margin improvements at Optum further contributed to the 140 basis point expansion in consolidated operating margin.
Operating costs grew seasonally to 15.7% of revenues. Execution across our enterprise continues to be strong and our financial flexibility remains distinctive. Adjusted cash flows from operations of $2,400,000,000 in the 3rd quarter brought year to date cash flows to 5 point $5,000,000,000 a 9% year over year advance. We ended the quarter with a ratio of debt to debt plus equity of 30 percent and had $1,600,000,000 in non regulated cash on hand. Last week, we announced our merger with Emil, the leading Brazilian health care company.
We see expansive early stage market opportunities there and we expect Immune will become a distinctive growth platform for both our Health Benefits and Health Services segments. The rating agencies all reaffirmed our ratings subsequent to our announcement. Standard and Poor had upgraded our corporate debt rating to A with a stable outlook in September, making UnitedHealth Group the highest rated publicly traded managed care organization they follow. Our unique business diversity was a key factor for S and P along with strong cash flow generated from operations. And also during the quarter, we were honored to added to the Dow Jones Industrial Average.
Let's review 3rd quarter performance by business, beginning with UnitedHealthcare, which advanced 3rd quarter revenues 8% year over year to $25,500,000,000 and operating earnings 26 percent to $2,200,000,000 UnitedHealthcare has added 2,000,000 people through the 1st 9 months of 2012. This includes net growth of 670,000 people this quarter alone, record organic growth for our 3rd quarter. Major new clients this quarter included the initiation of health benefit services for state employees in Texas and Nebraska who are honored to serve the employees of these states and their families. UnitedHealthcare grew fee based commercial benefits by 1,500,000 people in the 3rd quarter, bringing 9 month growth to 1,250,000 people. Commercial risk based business remained flat this quarter.
The commercial environment continues to be characterized by persistently weak employment and new business formation. The pricing intensity we see at local market levels remains unchanged from the last several quarters. Our offerings remain very competitive across the value spectrum due to our strong cost positions, effective care management, operating cost disciplines and innovative benefit designs and features. But we will remain disciplined on margins and continue to price to our forward view of underlying costs including the insurer's fee. As we hold to these pricing disciplines, we expect to continue to lose moderate levels of risk based membership in the near term as we have for the last several quarters.
Our Medicare and Medicaid businesses contributed strongly to UnitedHealthcare's 3rd quarter growth performance, together adding more than 165,000 people over the last 90 days. We grew by 35,000 seniors in Medicare Advantage and 70,000 Medicaid beneficiaries joined UnitedHealthcare Plans. We made the decision together with the state of Wisconsin to end our contract serving 175,000 people in one product in the Milwaukee market as of November 1, while we continue to serve 125,000 people statewide. UnitedHealthcare Community and State was awarded the opportunity to serve more than 20,000 dual eligible beneficiaries in Ohio beginning in April of 2013. This was part of the country's 1st Medicare Medicaid Eligible Program Award, integrating all services from comprehensive medical to long term care to pharmacy benefits to behavioral health.
We offer all of these services and are deeply experienced and skilled in integrating them to better respond to challenges for these beneficiaries. UnitedHealthcare's 8.6% operating margin strengthened ahead of both our expectations and last year's Q3 results. Our full year 2012 commercial medical cost trend benchmark is likely to come in around 5.5 percent plus or minus 50 basis points. 3rd quarter earnings benefited from reserve development and we now project a full year 2012 consolidated medical care ratio in the range of 80.5%. Based on the strong year to date results and the sharp seasonal increase in cost expected in the 4th quarter.
We believe our consumer education and engagement efforts and our clinical management and affordability programs are meaningfully impacting the cost curve for our businesses. With benefit design improvements and effective outreach and population health management, we're increasingly helping patients receive care from the best doctors and have better suited more cost appropriate sites of service. We have also grown our performance based payment programs, which are approaching an annual run rate of $17,000,000,000 or 18% of our in network medical spend and our ability to detect and errors in claim submissions and therefore to pay more fairly and appropriately for services rendered. Together these capabilities deliver fundamental value to clients by improving the overall affordability of the products they buy. Looking ahead to 2013, UnitedHealthcare's business plan is built on record customer growth, led by TRICARE and strong performance in the public and senior sector.
We expect UnitedHealthcare's performance in the public and senior markets will be highlighted by continued market competitive Medicare Advantage offerings, continued Medicaid expansion and a compelling new Medicare Part D product offering that fully leverages our PBM capabilities. We expect commercial risk business to continue to be down moderately in a price sensitive market as we adjust our pricing to reflect our forward view of medical costs trends and cost increases for the insurance fee provisions of the Affordable Care Act. We continue to expect generally lower gross margin percentage across UnitedHealthcare's risk based businesses in 2013 as we said last quarter. For the longer term, our view remains strongly positive. We believe UnitedHealthcare is building a distinctive health benefits franchise by aligning benefit designs, consumer engagement, clinical program management and network usage.
This alignment continues to deliver sustainable cost and performance advantages, growth and deeper richer relationships with consumers and physicians across all benefit categories. Moving to Health Services. Optum continues to progress steadily in line with the long term expectations we set out nearly a year ago at our investor conference. Even in these initial stages as the enterprise becomes what we refer to as 1 Optum, the results foreshadow some of the acceleration and impact of expanded capacities that will become even more apparent as it matures in 2013 2014. Optum's 3rd quarter revenues were $7,200,000,000 and operating earnings of $408,000,000 grew 28% year over year.
Importantly, all segments showed year over year and sequential quarterly operating margin gains, benefiting from growth and from the simplification and integration investments made in the first half of this year. The initiatives and investments that underlie the 1 Optum strategy continue and should benefit 2013 2014. 3rd quarter revenue growth was led by OptumHealth up 19% year over year and Optum Insight up 15% year over year. Optum Insight's revenue backlog continues to grow and now stands at 4,500,000,000 dollars up more than $700,000,000 or 19% year over year. The depth and quality of our customer relationships are increasing as the market becomes more familiar with our Optum offerings.
Some examples of new third quarter sales illustrate Optum's diverse and broad market reach. For a specialty drug maker, we will measure over multiple years the in market clinical performance of a high profile product. For a major care delivery system, we will provide technology and services to enable the development of competencies in population health and risk management. For a variety of health plans, we will deliver medical care to members through our integrated care clinics. For employers and freestanding drug benefit programs, we'll manage pharmacy benefits including their rebate programs and many more examples could be offered.
Optum is making steady progress in strengthening its margins by addressing its overall cost structure, operating processes and deeper product and business integration. We are committed to a higher performance, more responsive, more agile enterprise, consistent with results that have been realized over the years through similar approaches applied at UnitedHealthcare. We expect these improvements will strengthen performance for customers and unlock the scale advantage that should accrue from Optum's strong sustainable top line growth. We have added seasoned talented executives and aligned the organization to support more comprehensive solutions and deeper customer partnerships. We are focusing product development on these larger, broader opportunities, while continuing to execute on always important individual product sales day in and day out.
Our long term view for Optum's potential remains exceptionally positive. This is a competency based platform with leading assets that are applicable to serving a broad variety of channels, serving customer relationships across the full expanse of health system that needs to evolve and improve performance. We operate in an emerging health services marketplace characterized by fragmented suppliers, who typically are offering narrow products instead of broader based solutions. If we focus on our clients and the challenges they face and deliver strong execution around solutions, Optum has dramatic growth potential. So in sum, 2012 continues to be a strong year for our enterprise to this point.
Our results show growth and balance across virtually all our businesses. We've achieved revenue growth, further diversification and stronger margins. And we continue to develop and position our businesses and business leaders for the future. With Tom Paul taking an important new role as UnitedHealthcare's Chief Consumer Officer and Jack Larson and Steve Nelson, both strong veteran leaders now running respectively Medicare Retirement and Community and Save for UnitedHealthcare. 2012 should finish up strongly.
The 4th quarter is challenging from a seasonality perspective and as you know there's a heavy cost burden as we prepare for new January volumes and related benefit changes and as we work through the intense Medicare selling and enrollment season. That said, excluding any potential impact from EMEAL, we expect the year 2012 to end in a revenue range approaching $110,000,000,000 and an earnings per share range of $5.20 to $5.25 per share with strong operating cash flows of approximately $7,000,000,000 Quarter by quarter across the UnitedHealth Group, UnitedHealthcare and Optum platforms, we have We have been improving our products and services, executing more consistently and more strongly, diversifying steadily and regularly advancing innovations to better serve the needs of customers. Organic growth has been strong and distinctive in both 2011 2012. Medical and operating costs have been well managed with more opportunity in front of us. And as a result, we've been consistently delivering more value to the wide diverse and growing customer base we serve.
We expect strong execution to continue in 2013. But as we have said in previous calls, given the weak business climate and employment outlook in the United States, the mounting pressures in federal and state budgets, to mention just a few of the challenges, we continue to be cautious about 2013 earnings performance. We expect to grow revenues and earnings per share in 2013, but we view the current consensus level as a considerable challenge from this distance given these market conditions. We certainly expect to continue to grow broadly across our businesses in 2013 with the exception of commercial risk based membership. We continue to expect pressure on margins across all benefit markets.
We have TRICARE implementation and PBM in sourcing to add to the operating challenges as well as the growth opportunities. Optum should remain rock solid on its plan and continue to increase its contribution to our overall performance. And EMEAL is expected to be slightly accretive, but not really expected to be much of a factor in earnings next year. 2012 had significant favorable performance attributes, starting with favorable medical cost trends, reserve development and rebate true ups that we cannot assume will carry into 2013 with similar levels of impact. We will introduce our first view of 2013 to you at our Investor Conference in just over a month from now.
As 2012 closes, we continue to generate significant growth momentum. Our customers are responding to the distinctive competencies that underlie products and services excess from both UnitedHealthcare and Optimum. We will continue to focus on fundamental execution with the goal of creating value both for those we serve and for shareholders. In the meantime, our team is here to take your questions about market development and 2012 performance. Please let's hold to one question per person.
Thank
you. Our first question comes from Matt Borsch with Goldman Sachs. Please go ahead. Your line is open.
Yes. I just wanted to ask you about the commercial pricing and cost trend environment. I mean, in particular, of course, I noticed the lower outlook on trend now at 5.5 percent down from your prior outlook. Can you just talk through the components of your view that changed during the quarter? And also maybe just dovetail that with whether you've seen any change on the pricing side as well?
Sure. I think Dan might be the best to begin that.
Good morning, Matt. This is Dan Schumacher. Good morning. So on the cost trend side, stepping into 2012, we did have an expectation of higher utilization as compared to 2011. We are actually seeing that, although I will tell you it is more moderate than we thought.
We saw a surge in the Q1 utilization and then that moderated from the Q2 forward. And I think beyond the consumer behaviors underneath that, I think what we are seeing is some really strong contributions from our medical affordability agenda. We work across the healthcare landscape, whether it be inpatient management, focused on the most appropriate site of service, most appropriate course of treatment, all the way through to payment integrity, fraud, waste and abuse and strong delivery frankly from our contracting aligning more around value and quality outcomes. So all of those things are making difference for us. As you look at the components of it, I guess I would take you back to the investor conference guidance and update the components from there.
First on inpatient, we are seeing a little better inpatient. Again, that's really our strong management on one day lengths of stay observation conversions and things like that. We are seeing a little bit more moderate pharmacy utilization, particularly in the space of hep C. We're seeing relatively stable physician and outpatient is actually a little bit higher than our expectation. And we continue to have strong programs really focused on the site of service the outpatient setting.
So all of that informs our revised view of 5.5% plus or minus 50 basis points. And then I think I'll turn to Jeff to talk a little bit about the pricing environment.
Good morning, Matt. It's Jeff Alter. So on a general basis, we've said this before, we had expected and have been seeing a more competitive market environment around commercial pricing. I don't think it's changed. It's about the same as it has been through the 1st few quarters of this year.
So not really a market change in the Q3. But as you know, our approach hasn't changed for a very long time. Our approach and discipline remain intact. And as Steve mentioned, we believe the result of that will be some loss of commercial risk based membership over the next call it 6 months. And in relation to the discussion or the answer that Dan gave, we have a very disciplined process that takes a forward view of costs and as medical trend changes and expectations change and those results change, we look across those 350 intersections of MLR and then look at a couple of other factors and try to come up with the answer that will optimize our results in each one of those given markets.
So that has remained unchanged. What has changed I think internally is we are able to get some of these changes into our pricing much quicker than we had in the past.
Great. Thank you.
Next question, please.
And we'll go next to Josh Raskin with Barclays. Please go ahead. Your line is open.
Hi, thanks. Good morning. Just wanted to talk a little bit about the commentary you made on 2013 consensus. Steve, you mentioned that that would be a challenge. I think the consensus versus the midpoint of your current of your updated 2012 is about 7% growth.
So I guess a couple of things on that. We've heard from the company before that it's a double digit earnings grower. Are we just in sort of last couple of years, we're just sort of not seeing necessarily all of that if you take out some of these one timers. So are we thinking about the growth trajectory wrong? You guys seem comfortable that Optum is still on pace to double by 15%.
And then I guess you mentioned pricing for the industry fee. Is that having a bigger effect? Is there a net income impact next year? And maybe specifically how you plan on accounting for that?
Well, Josh, I think that is like 6 questions rolled into 1. So I really commend you
for that.
Our view in terms of the outlook of our business is unchanged. We have seen these kinds of challenges in the marketplace and I think we have been successful in navigating through them over the last couple of years. But that doesn't deter us from recognizing that we need to continue to operate and focus on that basis that the economic environment has not changed. The employment outlook really has not changed and doesn't appear to us to be. The reimbursement environment relative to the federal and state budgets arguably has gotten even more intense.
The impact of the Reform Act including the insurance fee really begins to get in come into play as we set begin the rate development process for 2013. So we are respectful of those elements and intend to engage them and to perform to our maximum potential through those and are perhaps more cautious than those who set consensus of those factors at this distance as we look into 20 13. If you actually take a look at our actual performance, I think it has been pretty strong over the last couple of years. And we are certainly focused and actually think we are more capable and stronger than we have been in those past years. But we have to strike an appropriate balance there and that's really all we are saying.
We expect to grow revenue and earnings in 2013. We're really not intending to give you more specifics or color on our 2013 guidance other than to maintain a sober balance in terms of some of the headwinds that we see. And from a growth perspective, we consider these to be kind of the headwinds of perhaps the next couple of years. But if you really take a look at the potential of this enterprise, the market expansions that are in front of it over the long term, The Optum is performing well. It is maturing.
It is gaining momentum and we fully expect to be in line with our kind of the guidance, the longer term guidance we set at last year's investor conference. So no discouragement along those lines. And I don't know what else to offer. So
I understand Steve you're not going to give sort of specific guidance. But you talked about the industry fees. So I'm just curious what the impact there is. Are you is there a specific percentage you're assuming that the fee will come in at as a percentage of premiums? And are you accruing for that in 2013?
Is that the idea?
Well, so it's coming into play in 2013 because it applies in that fashion. Maybe Dan Schumacher can address the insurance fee. Sure. So with respect to
the accounting,
the insurance fee is assessed in 2014 based on 2013 premiums. So we will begin accruing for it in 2014 as premiums are earned and we will actually make the payment in January of 2014. So that's kind of mechanically how it works.
You said you're accruing in 2014?
We're accruing in 2014
for the fee. With respect to pricing, in the commercial business, we have annual policies. So those policies that begin February forward in 2013, they have months that carry then into 2014. So we are increasingly reflecting the health insurance tax in those renewals, so that we capture the cost of that tax in '14 in our premiums in 'thirteen.
Okay. Thanks.
Thank you. Next question.
And we'll go next to Justin Lake with JPMorgan. Please go ahead.
Thanks. Just want to follow-up here on the commentary, commentary specifically around the revenue growth. Obviously a strong year here across just about all the businesses on the membership side. Is there anything you can talk to just in terms of anything we should be thinking about structurally in terms of the growth that you saw in 2011, March 31, 2012 that may or may not continue into 2013 whether that's the strong commercial ASO business, the Medicare Advantage results. I know you had a good Part D bidding season.
Just curious if there's anything we should be thinking about in terms of non repetitive?
I think I'll let Gail and Larry comment with respect to their business platforms, but the item that we really highlighted was really no different than 12 and that is continued moderation in terms of commercial risk. Gail, do
you want to? Thanks, Steve. Good morning, Justin. From an overall perspective, as you've seen from the benefit side of business, we've had a very strong growth trajectory over the last several years, including this year in 2012. As we think about the positioning of each of our businesses, certainly, we're coming still into the final pieces of our selling season for 2013, but feel we're well positioned the commercial ASO side and think we will have another strong national account season.
Again, that's part of the positioning around our consumer facing products, our value based benefit design, the innovation that we're bringing to the market. So we feel positive about our positioning in the commercial ASO side. As Steve mentioned in his opening comments around commercial risk, it's a very competitive market. We're staying extremely disciplined around the pricing components of that and would expect to see membership decline. But again, feel good about the positioning of our products in each of our local markets.
On the Medicare and Medicaid side, from our as you know, we're just starting into the AEP season. Again, we feel we have a very balanced offering in the marketplace and feel good about our Medicare positioning and Medicare Advantage had a very strong Medicare Supplement business this year and would expect to continue to see strong performance there and feel we have a balanced offering in Part D as well. On Medicaid, we've continued to win procurements. And again, that is a market where we know that states are facing some significant budget challenges. We see opportunities.
We're pleased with the win that we had in Ohio on the dual eligibles as well as the state Medicaid and the procurements there and continue to get very focused on affordability and providing, I think strong offerings to our state partners both across Medicaid and Medicare. So overall, from a growth perspective, getting back to your question, I think we feel well positioned, but recognize the competitive nature of the marketplace and are very respectful of that.
Got it. So the
kind of
net answer here sounds like the business momentum feels just as strong going into 2013 as it was going as it kind of has continued to be during 2012. And the commercial risk business is the area where you see pressure and that's no different than what you've seen this year in terms of the economy. Is that a fair way to look at it?
Well, I won't comment on 2013 guidance, but I'll tell you that we do feel we're well positioned.
Okay. Great. And you've only been part of the story because Larry Renfro can speak to the Optum side. Hi, Justin.
Hey, Larry.
I think everybody knows that we have a 3 year business plan that we're operating under. We call it becoming 1 Optum. And if you look at that plan and you look at the execution that we've been achieving this year, there's really 4 areas that I'll give you a little detail behind that. 1 being financial disciplinecostmanagement, 2 being reengineering organizational simplification, 3 being portfolio management and 4 being growth. So I think in terms of your question, you were more geared towards the growth.
So let me just give you a couple of comments. We do feel pretty well positioned. I think if you look, this quarter, Optum Health was up about 19 percent, OptumInsight up about 15% with OptumInsight's backlog being up about 19%. But if you look at growth where we see it coming from in the future as part of our plan, it will be the PBM, it will be carrier delivery, the retailconsumer and the provider. So we feel pretty good about the overall plan.
We feel pretty good about the execution in 2012 and looking forward to some results in the future. Great.
So overall, I'd say pretty
positive. Okay.
Next question please.
And we'll go next to Ana Gupte with Sanford Bernstein. Please go ahead.
The question is about cost trend both around utilization as well as unit cost. So can you give me some color first around the reserve development, which is very favorable compared to some of your peers in recent quarters by segment, Medicare, Medicaid, commercial and if utilization is equally weak and well controlled in all segments? And then on the unit cost side, given that we've got now 40% of docs owned by hospitals per the recent advisory board data, Sutter, Long Island Jewish, New York Montefiore and many others are beginning to apply for health plan licenses. Are you seeing any pressure on your unit costs? And how do you see that evolving in the next 1 to 3 years?
Dan? Hi, Ana. This is Dan Schumacher. So let me take the pieces of that. First, with respect to the reserve development, I think it's important to share that our fundamental discipline has not changed.
So we have a comprehensive reserve setting process. It's consistent. It's stable. And each month, each quarter, we are trying to sort out our best estimate of the ultimate claims expense. And as a result, we don't have any expectation of future favorable development.
And as you look at it on a year to date basis, look at it in relation to prior year medical spend and so forth, it's about 1%, so in a relatively reasonable range. In terms of the things that are contributing to the development, let's say first on the utilization side, as I mentioned, we saw a surge in utilization in the Q1 and some moderation in the Q2 forward. And that's true across Medicare, Medicaid and commercial. And that contributed to our development. We also continue to have improving processing speed as well as processing quality.
That's showing up in the form of reserve development. And then beyond that, our performance around our affordability agenda. So we take a prudent approach. As we introduce programs, we wait to see that manifest in actual claims payment and then that starts to impact our reserve results. And so you're seeing favorable development across kind of those three things.
As you look at the composition of trend between cost and utilization, utilization is a little bit better than we expected. And I would likewise say that unit cost is a little bit better than expectation. On the commercial side specifically, it remains an area of intense pressure for us and it represents more than 2 thirds of our trend outcome each year. So it is a very meaningful part of our trend equation. But I will tell you that on the unit cost side, we are doing a little bit better than we thought.
We think that's in part due to the reconfiguration of our payment aligning it with performance and quality and
value. So it's P4P and you're turning more to shed savings risk based contracting, if I may just close that out?
Yes. We're working up the continuum. So starting at fee for service and then working towards shared savings and gain sharings up through bundles and episodes, ultimately sub capitations and capitations and so forth, working to align the incentives across the continuum. And we rely heavily on our partners in Optum to help to provide the services and support tools for the delivery system to be able to meet us where we want a contract.
Great. That's helpful. Thanks.
Thank you. Next question.
And we'll go next to Sarah James with Wedbush. Please go ahead. Your line is open.
Thank you. Steve, I wanted to clarify a comment that you made in the prepared remarks. You said that you'd expect commercial risk business to be down moderately next year. And I wanted to understand better if that was referring to top line or margin because it sounded like you thought the intensity of pricing competition was continuing and costs would be up next year. So looking at those two pieces together, where do we end up from a margin perspective?
Sure. I think Gail can respond to this.
Sure. Steve was referring to is that, as you know, this year we're down in enrollment over 200,000 205,000 lives on the risk base. And as Jeff said in his comments to the earlier question, we expect it to continue to be a competitive environment and we would expect enrollment to be down.
Got it. So the comment was directed at enrollment, not at margins?
Yes. It was at enrollment,
Thank you.
We'll go next to Ralph Giacobbe with Credit Suisse. Please go ahead.
Thanks. Good morning. Just want to go back to cost trend. I know you took it down a bit. Maybe can you talk about what you expect on the inpatient and outpatient side or what you're seeing in terms of trend there?
And then you mentioned sort of the shift to inpatient and outpatient. How much of that is really driving the lower cost? What you're doing to help that push? And if at all, if you can frame sort of the savings in aggregate on a like for like basis?
Dan, do you want to cover that again?
Sure. So with respect to the categories, where we're seeing utilization up, we're seeing it up in the outpatient setting. And that is in part due to some of the management programs we have in place. So we focus on converting one day lengths of stay to a more efficient setting to observation status. So they flip from inpatient to outpatient and that was what I was talking about with respect to our management programs.
And then on the inpatient side, we are seeing continuously restrained utilization. Our bed days are actually flat to declining in each of our benefits businesses. And those things extend through from admissions, the length of stay as well as focused on the readmission rates, so that when you leave the hospital, you're able to stay home. And again, that's an example of a partnership with Optum where their management teams are working to transition people to the home setting and help them stay there. Those are some of the examples of the things that we're doing that are making a difference inside of our cost trends.
And then just again just on the 5.5%, I guess I'm just trying to get a sense does that equate to inpatient being up 4% and outpatient being up 9% or can you help in that regard just trying to get a sense of the magnitude when you talk about inpatient and outpatient given that you lowered the trend?
Well, so when you're talking about the trend, you got to take into account unit cost and utilization. On the utilization side specifically, inpatient is actually down, outpatient is up. On the unit cost side, most of our unit cost increases come in the inpatient setting. That's where our increases are coming from. So when you blend that all together, as I mentioned before, balanced against our investor conference guidance, better in inpatient, better in pharmacy, relatively stable in physician and higher in outpatient.
Thank you. Next question please.
And we'll go next to Melissa McGinnis with Morgan Stanley. Please go ahead.
Thanks. Good morning. 2012 was definitely a year of investment not just around your Optum segment, but also in preparation for certain regulatory changes and reform inflammation in 2014. Can you just help us think about any incremental investments you may still need to make as we head into 2013? And whether there's any sort of step function change up or down in your SG and A as we head into next year?
So let me see if I can understand the question. As we continue to prepare for adopting and embracing the health care reform changes and continue the activities in our business such as in sourcing our PBM, etcetera. You're asking where our costs you're looking for an increase in cost or something like that? Is that
Yes. Sort of just how we think about your SG and A, especially around those types of investments as we move from 12% into 13%.
I think 12% has actually had reasonable burden with respect to those kinds of investments. And I think much of it will carry through into 2013 and probably subside more in the latter stages of it. But I think the area that's most impacted by those kinds of activities is Optum. So maybe I'll ask Larry or John Rex to kind of
comment. Sure. If you and I think that most people know that we have spent the last couple of years designing the PBM operational platform as well as the infrastructure to move the UHC business on to our platform. So 2012 ended up being the strong year for us to invest. That investment should start to wind down at the end of this year and there'll be some lag into 2013, but we feel pretty good about where we're at with that It's perfectly on plan.
So that's pretty much John. I don't know if there's anything else.
Yes. So what I would add to
that Larry is that and you're absolutely right. This is Dirk McMannen. In 2012, we had probably our highest SG and A burden associated with investments in the in sourcing. But in 2013, we'll also have some expenses associated with training of people as we bring them in to deal with the membership that we will ratably bring in through 2013.
I would just follow on here.
I think in the first half of the year, we made comments in the first two quarters about investments we're making across the broader business in addition to OptumRx. And we expect to continue to make those investments. And I think some of what you're seeing in this quarter is we're starting to realize some of the benefits that we would expect to continue to make with investments as we work out into 'thirteen also.
But nothing but basically continuation, nothing A continuation of kind of level. And how about on the UnitedHealthcare side?
Good morning. It's Gail Boudreaux. On the UnitedHealthcare side, you'll continue to see, there's some investments stable investments in reform. So you think about ongoing investments in ICD-ten. In addition, we made investments this year in 2012 in helping to stand up the TRICARE contract and we will continue to make those as we prepare to serve that membership in March of 2013.
And those investments will getting that 2013.
Great. Thanks.
Thank you. Next question please.
And we'll go next to Peter Costa with Wells Fargo. Please go ahead.
You guys talk about Optum growing and margins continuing to improve and then SG and A being perhaps higher in 2012 than maybe in 2013 or at least similar but not growing and talk about building the insurance fee into the commercial risk business. So I'm trying to gauge why the pressure on EPS growth making earnings growth the consensus numbers challenging for 2013. It comes sort of down to the Medicare business and we look at that and you clearly have very good margin in the Medicare business or certainly a lower medical loss ratio. Are you sort of expecting a much weaker margin in Medicare for next year, sort of getting ready for the MLR minimums in 2014? Is that the way to think about this?
Yes. No, maybe I could reset. I think if you go back to the commentary we have made really over the last couple of years, really it is respond we're responding to an environment that is broadly challenging and where we have been successful navigating those challenges, those challenges remain. And the economic environment remains and the pressure on budgets remain. And the pressure on making sure that we which we have a lot of respect for the work that goes into executing across those.
And basically, we remind the market each quarter about those challenges and we approach things perhaps more cautiously than the marketplace. And I think that's all we are suggesting. We are really not you are perhaps over analyzing if you're trying to focus down on a single product line. We're actually pretty positive about the breadth of our business, very positive about our Medicare and Medicaid outlook and potential, actually very positive with respect to commercial. If you take a look at the commercial market broadly, it has been at best treading water if not contracting from that perspective.
So we're just reminding the marketplace of those challenges in light of very, very strong results. So that really is the goal here. Not there is no lack of confidence with respect to our competitiveness in the marketplace, our ability to prosper under all the product lines we have right now.
And just getting back to the minimum MLRs in Medicare, can you address that a little bit in terms of how well you think you are prepared? I don't even know how that's going to be calculated at this point. But in terms of your expectation for how that's going to work going forward, what kind of pressure do you see on margins in the Medicare business in 2014, if not sooner?
Actually, we feel pretty good about that Gail.
Yes. I think this is Gail Boudreaux again. I think you said at first, we don't have
the exact calculation yet for how the
minimum MLR will be applied in Medicare. But it is obviously one of those factors that as we get into 2013 and prepare our bids for 2014, we'll take that into consideration along with a number of other factors. But to be more specific, we do expect to be able
to manage within it.
Okay. Thank you. And if I would add, one other element to the thinking is that 12 has had a lot of favorable elements to it. And as I said in the prepared remarks, you cannot necessarily assume that those will play into 2013 as strongly as they did in 2012. We will continue to operate in endeavor to achieve that, but that's an element of caution that we also give.
So I wouldn't over read our caution. I would just think that we have to regularly remind ourselves and remind the marketplace of the issues.
Thank you much.
Good question. Next please.
And we'll go next to Kevin Fischbeck with Bank of America Merrill Lynch. Please go ahead.
Okay, great. Thanks. I just want to go back to the industry fee pricing commentary. So you guys are starting to price for the industry fee starting next year, but there's no actual fee until 2014. So shouldn't that be a tailwind to 2013 MLRs?
Dan, review that again. You're right, Kevin. That will provide a little bit of help in 2013 as we collected our premiums the cost of that tax in 2014 in the commercial space.
Okay. Because if some reason maybe I was misreading it, but it sounded to me like you were saying the industry was some sort of headwind that had to be dealt with. Is it just more on the commercial membership side that you're talking about? And if you believe that it is in some ways a headwind on the commercial membership, does that mean that some of your competitors, I guess, most of the nonprofits because the for profits have kind of indicated similar pricing dynamic to you. Does it mean that some of the nonprofits are not following that strategy?
We really can't comment. We don't really know the strategies others are following. This is an element that is part of our rate development. The headwinds we talk about are the fact of the market coming to grips with this element of pricing as it goes into our rate development process. So really that's what we are talking about.
You're right about it being a tailwind in terms of that element. And we really aren't going to comment about how others are going to approach this.
And any further things to add? Yes. I just think, Kevin the pressure that we're talking about is really the increase in pressure on already strained employers, consumers, federal and state governments. It's really the pressure it adds to the system as it adds another cost in the environment. And I think just in terms of how this is recovered in 2013, I do want to clarify that it is ratable.
So if you're a February 1st effective date, we would be looking to recover the month of January in 2014. So 112, 212, 312 and so forth.
Yes. So as the year goes on that would increasingly be a benefit. But then as you roll into 2014, it's now a net neutral aspect. But I guess as you thought about that, I think there's a comment before that you expected margin compression in your business lines. Is that because the favorable development is not going to re accrue into net even though you're going to have a pickup in the tailwind in 2013?
This fact that you don't assume favorable development they wash? Or how do we think about that?
Well, the only thing I'll leave there is that we do not assume development going forward. We believe our reserves are set appropriately. And so we don't really have a view of reserve development going forward.
Okay. Thanks.
Thank you. Next question please.
And we'll go next to Scott Fidel with Deutsche Bank. Please go ahead.
Thanks. Just wanted to stick on the industry tax subject and maybe if you can just talk about what some of the latest feedback that you're getting from CMS and from the states is if you're getting any in terms of how they're planning to build in the tax into the rates for Medicaid and for the Medicare products?
So Scott, good morning. With respect to Medicaid, again, this will be an element of the cost structure that will go into our rate development. And this along with all the other factors that go into rate development will be part of our dialogue with our state partners over the course of 2013 as they start to set rates that flow into 2014. So I would say that conversation is on the horizon in earnest. And then on the Medicare side, it is going to be one of the factors that we consider in our developing our bid strategy and bid approach for 2014.
So as you think about the 1st 6 months of next year, we'll be taking into consideration the health insurance tax as well as all the other changes and then trying to ultimately preserve the value of the benefits that seniors really enjoy.
So Dan, is it fair to think about for Medicare that we won't actually be seeing when CMS gives us preliminary and final rates for 14. There won't be an adjustment in the rate, it's more that the industry will need to adjust the benefits and the pricing to accommodate the tax?
I won't comment on CMS rate setting. I think our expectation is that as we formulate our bid approach, we'll need to consider this as another element in that approach. Okay. In fact,
the EMS will have to consider it as well in terms of how they survey the private sector market for Medicare Advantage. So these conversations are really just beginning. This is really just getting introduced at this point in time across basically all elements of rate development, whether it's commercial or whether it's in the government programs. Next question please.
And we'll go next to Jason Gerda with Leerink and Swan. Please go ahead.
Good morning. One of your peers recently commented on their expectations for margins in the small group and individual product in 2014 on the exchanges. Could you provide maybe a little bit of commentary or perspective on what you are expecting or how you expect the margins or how you expect the exchanges to impact your margins and maybe your perspective on what your competitor had stated?
Sure. Gail and Jeff want to touch on this?
Yes. Well, why don't Jeff and I give you a little perspective. I'm not going to necessarily comment on our competitors' perspective on the marketplace. But I think we want to put this a bit in context. The small business has always been a very competitive and a very transparent market.
That's a market we've done very well in. We see it as a robust market. And quite frankly, the focus has always been about on affordable price points, strong consumer engagement and making sure that you have a cost structure that underlies that strong positioning. So as we think about exchanges going forward, there's a wide range of expectations around the migration to exchanges and we expect that to be measured as we head into 2014. Part of that is due just to the ability of getting these exchanges up and running.
The second one is that employers, as they think about the tax advantage they currently have and then the need to have to make that up in compensation or other things, that's one of the reasons we do think it's going to be measured. But with that, we do expect that there will be pressure in margins over the long term. And I think that goes back to underscoring the importance of having affordable plan design, strong network composition, making sure that your cost structure is aligned. But we do also see opportunities for growth given that opportunity, given the positioning of ourselves in the small business market. And maybe I'll ask Jeff to comment a little bit about that as well.
Good morning, Jason. It's Jeff Walters. I agree with Gail's comments about the existing small group market. Also just remind that we have been involved in exchanges for quite a long time, certain states, certain industry associations. So some of the lessons learned there, I think are applicable as well for product design, choice around network constructs.
So there's still a lot to know about the exchanges. Things are being developed right now. We don't have all the rules. But I think as the exchanges become more firm, we will engage with those constructs and apply some of the lessons that we've learned over the years in our small group business and in the participation in the number of exchanges to that marketplace. We don't we see it as just another distribution in another marketplace and we'll react to that marketplace like we have the overall marketplace.
And the only thing I'd add is that there's really nothing new there. That basically reflects our thinking and our posture probably for the last 2 years or more. So there really isn't anything new. Those pressures have been there and we expect them to remain. Next question please.
And we'll go next to Chris Rigg with Susquehanna. Please go ahead.
Good morning. Thanks. Just wanted to come back to the cost trend real quickly here. Relative to your initial trend guidance, is it fair to say the new level is down entirely because the utilization component of trend is lower than relative to original expectations? And then I guess more importantly going forward is even where you started this year it had up about 1.25% or so.
Is that sort of the new normal that we should think about as the right level prospectively? Or would you guys assume that that eventually does reaccelerate? Thanks.
Good morning, Chris. This is Dan. On the Quest trend, the improvement in our guidance, that 50 basis point improvement at the midpoint, that is a blend of improvement both in utilization and a little bit better unit cost. So both are making a contribution to our 2012 cost trend view. As we think about our cost trend into 2013 in the commercial business, we expect the trend to be relatively stable.
Okay. Thanks a lot. Thank you. Next question.
We'll go next to Christine Arnold with Cowen. Please go ahead.
Hi. A couple quick questions. Are you assuming in kind of your cautious outlook the potential for the fiscal cliff and other situations not to be resolved favorably enough to have potentially a similar what you were thinking what you were thinking there? Thanks.
So 2, I'll have Dirk talk to or the who wants to do with the Part D. Okay. And then are the elements of a fiscal cliff and so forth specific? No, I think they're part of the landscape and what we talk about when we talk about the pressures that are on government and so forth. I don't know how one would actually feather in that in a specific way, but it is clearly a factor in our caution list as we think about 2013.
So clearly, we recognize it. Clearly, we're focusing on its impact in terms of potential impact on government programs and so forth. But nothing that we can actually specifically do, but a good reason why we stay more cautious than perhaps the marketplace. And with respect to Part D? Christine, good morning.
Jack Larson. So
on the Part D Savor plan, I guess as market leader, we had a point of view that we need to be serving the broader market. So we set out really to design a plan that appeal to those consumers who are really more, I guess, economy minded, more sensitive to the fixed premium rather than some of the other plan features when you compare that to the preferred plan that we offer today, which is in comparison relatively more comprehensive. Now I guess having designed that product for that consumer segment, I guess we're just happy that the plan actually attained below the benchmark status and we get a chance to serve the low income population for calendar 2013.
And your assumption is that the medical trends
upticks
in commercial?
It's John Van Schorn.
I think Dan was referring to a stable rate of increase as opposed to 0% year over year.
Got it. Thanks for clarifying.
Anything further?
No. The only thing I'd add, Christine, to Jack's comments around Part D is part
of the
I think the value is looking at the marketplace, as he said, and assessing it and then also our partnership with OptumRx, our ability to manage formulary effectively, our retail network as well as our overall program. We think that adds unique value to us and our ability to play in that marketplace and broadly serve both the low income as well as the retail market.
Thank you. Next question. We'll take maybe 2 more questions.
We'll go next to Cheryl Skolnick with CRT Capital Group. Please go ahead.
Good morning and thank you. First of all, it is a very hard work to do everything that has been accomplished at United and everyone there should be congratulated on the execution in a challenging environment. And I want to thank you, Steve, for the appropriateness of the reminder of how challenging it is and also for the fact that the tone is while cautious not nearly as pessimistic as it was last year and so the stock is having heart failure. But my question is this. We've talked a lot on this call about what happens as reform is implemented.
But there is a nontrivial risk at this point that we could have the 3 Rs on the Hill and in the White House. And if we've got Romney, Ryan and we've got Republicans running the Senate or at least a split Senate, so a 51 going to Republicans and a Republican House, it is possible that reform may change materially, if not go away completely, in some way, shape or form. So my question to you is, what happens United in the event that reform doesn't happen? How are you positioned to succeed?
Well, Cheryl, regardless of what legislation went in place, some of the underlying elements in the marketplace that led to policy initiatives around making the health care system more effective and efficient, modernizing that system, expanding and addressing areas where coverage was not sufficient access needed to be better channels needed to be established. Making the being able to deliver more consistent quality, getting at the underlying costs, all of those elements contributed to kind of this national conversation around health care and the result of a first policy initiative, which was largely around the expansion of coverage. And I think everybody recognizes there will continue to be work to be done to improve the health care system, both from a policy point of view and from an operational point of view. That's what we do. That's really where the mission of this enterprise is.
So regardless of what comes forward in terms of policy and what generations follow it, we will respond and operate and work within the system to maximize the potential of this enterprise as commercial enterprise and to maximize our impact on the healthcare system in total. So if there is a change in direction with respect to healthcare, we will maneuver and evolve and adapt to that change. We've talked about our adaptability for years, we don't think the underlying issues change. Fact of the matter is coverage needs to be better considered, costs need to be addressed more effectively, the system needs to operate more efficiently, Resources need to be accessed in a fair way and gone further and the consistency of the processes and so forth need to advance. All those elements are things that basically work to our competencies and the strength of our businesses.
So we will just adapt, if you will, to those kinds of changes. And I think as an organizational capability, we have very, very strong adaptability skills. So that would be the response. We really will never comment in terms of a political persuasion one way or the other. We will respond to what the market how the market begins to evolve and we'll adapt to serve it.
So and just to follow-up. So in terms of the contingency plan, is it fair to say the entire company strategy is the contingency plan?
Yes. I think the whole nature of this organization market challenges. So the whole construct modular development of the business, built around competencies, the fact that we deploy and redeploy kind of almost on a non stop basis is really how we approach serving the marketplace. And if there are changes, we obviously have thought through the kinds of changes that could occur. We think we can respond to them very effectively.
Thank you very much.
Thank you. One more question.
And we'll take our last question from David Windley with Jefferies. Please go ahead.
Thanks for squeezing me in. So Steve, as I think about adjusting my outlook, our outlook relative to the cautionary comments that you've made on the call, I'm interested in kind of thinking about whether that is pulling back a little bit on Optum and UnitedHealthcare or if it's more heavily weighted toward one side or the other? And thinking about Optum, you've got the UHC business coming in, preparatory costs winding off, margins in all three segments there seem to be progressing pretty nicely. And so it would certainly seem to point toward lower expectations on the UHC side of the business. I think most of your comments point toward that on the call.
I just want to make sure I confirm and understand that being the case. And in particular that it would be in the commercial risk business that you would point to as being the maybe the area of greatest weakness
for lack of better word?
Actually, our goal is really not to provide that kind of specific guidance for you today. It is really more of a messaging that we take perhaps a more respectful and cautious view of the market in total. We also recognize 2012 has been a strong year and has benefited from a number of positive things, which we hope will continue, but we can't be sure of. We're certainly confident in our Optum business, but we're also very confident in our UnitedHealthcare business and businesses. The commentary around the commercial marketplace is almost identical to last year.
I mean, we were saying the same things last year about moderation in terms of growth in the commercial risk segment and we are saying it again this year. We are down about $200,000 in commercial risk and we consider that to be a moderate level. So we are not trying to signal alarm in any particular area. We are really just suggesting that 2012 has been a very strong year. We expect 2013 to grow in both revenue and earnings.
But as we sit in October of 2012 and assess the challenges ahead. We hope to continue the strength of this performance. We're actually in a good or better position than we were at this time last year. But we think we're being cautious and we think the market should be cautious as well. And that's all I can offer you until we discuss this at the Investor Conference in more detail, which is not just a little bit more than a month.
Okay, very good. Thank you. Thank you. So as we wind it up, I think UnitedHealth Group continued to deliver a solid performance in the Q3. We remain cautious about the challenges ahead and we certainly discussed that well perhaps.
Most critical though in terms of the challenges of the continuing work to really improve the quality of the healthcare system to control the rising cost of care and to really work to serve the people that we serve across the enterprise. So as we said today, we're very optimistic that we have the people of this company. We'll rise to the challenges across the board. And we look forward to seeing you at the Investor Conference in just a little over a month. So thank you very much for joining us this