Good morning. I will be your conference facilitator today. Welcome to the UnitedHealth Group Second Quarter 2012 Earnings Conference Call. A question and answer session will follow UnitedHealth Group's prepared remarks. The question and answer queue will not open until the conclusion of the prepared remarks.
As a reminder, this call is being recorded. Here 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 in our Form 8 ks dated July 19, 2012, which may be accessed from the Investors page of the company's website.
Would now like to turn the conference over to the President and Chief Executive Officer of UnitedHealth Group, Stephen Hensley.
Good morning and thank you for joining us. Today, we will review our second quarter and first half twenty twelve results and discuss the near term outlook for our businesses. In the Q2, UnitedHealth Group earned $1.27 per share, an advance of 9% year over year on revenues of more than $27,000,000,000 which increased by 8% year over year. Our consolidated medical care ratio of 81.3% reflects strong performance on medical cost results that were slightly better than expected, primarily due to favorable reserve development. The operating cost ratio of 15% reflects continuing growth in services at both UnitedHealthcare and Optum and the investments we are making to advance our Optum businesses, particularly pharmacy services.
Efficiencies from our multi year operational improvement efforts partially offset this cost growth. Adjusted cash flows of $2,000,000,000 brought first half twenty twelve adjusted cash flows to $3,000,000,000 up $615,000,000 year over year. Our financial flexibility continues to be distinctive. In the first half of this year, we grew our dividend payment rate by 31%, extended our share repurchase activities, closed 3 acquisitions in Medicare and still maintained a debt to total capital ratio of 30% and $1,000,000,000 in available cash. Annualized return on equity through the first half of twenty twelve was 19%.
Let's review our business results starting with UnitedHealthcare, which continues to sharpen its innovative focus toward greater simplicity, quality, affordability and consumer value. UnitedHealthcare provided medical benefits to nearly 36,000,000 people at June 30, an expansion of 1,700,000 year over year and an increase of $305,000 in the quarter. 2nd quarter revenues increased 8% to $25,500,000,000 and the outlook for new business remains strong. Looking forward, recent successes include affirmation by the government of our mid-twenty 13 TRICARE award for military benefits for The Kansas and Ohio awards for Medicaid benefits and the selection of UnitedHealthcare by Texas and Nebraska to provide health benefits to their employees. These awards and less publicized engagements we're winning day in and day out reflect our commitment to serve, to execute and to innovate.
Breaking down 2nd quarter results, UnitedHealthcare employer and individual year to date growth stands at 550,000 consumers served, which reflects a decrease of 25,000 people in the 2nd quarter as we expected. Favorable cost trends and overall client remain key positives. Our service reputation remains strong. Customer retention is high and response in our newer, more innovative products and technologies continues to grow. The value of our network our networks deliver in care quality and cost containment is high, but we are seeing an ongoing shift in market priorities.
Large sophisticated buyers are placing their business based upon well aligned consumer and care provider engagement, aligned to effective clinical management capabilities. Collectively, these elements have positioned us to continue to add value and grow our self funded business into 2013. For the risk based market segment, the competitive climate continues to be aggressive, but rational. This remains consistent with what we have been seeing for more than a year. Some pricing we see in select regional markets seems to reflect the of any rebates under minimum MLR provisions.
We expect this market to continue to be highly competitive into 2013. We will hold fast to our disciplines and accordingly expect continued pressure on a risk based product membership. We believe customers and our company are better served by consistent and predictable pricing supported by a realistic view of forward cost trends. In Medicaid, UnitedHealthcare Community and State continues to grow steadily, adding 210,000 people served this quarter and a total of 275,000 people year to date. New implementations and new awards in 2012 include Louisiana, Texas, Washington State and Kansas.
In Ohio, we received awards for both the traditional Medicaid population and for dually eligible residents. We now serve Medicaid programs in about half the states in the U. S. This includes services such as behavioral healthcare and pharmacy benefits, which state customers increasingly seek to integrate into their Medicaid offerings. Service to the duly eligible and integrated benefit offerings both play to UnitedHealthcare's historical experience and strength.
As with our commercial benefits, UnitedHealthcare community and state remains disciplined in ensuring we achieve an appropriate return on the capital we've invested. We continue to take a prudent market sustainable posture for both new bids and maintenance of existing relationships. We remain committed to partner with states that are committed to the long term viability of their programs. While we will withdraw from programs within states or change the nature of our service to those programs as needed in instances where we see that commitment to viability weaken. UnitedHealthcare Medicare and Retirement completed 2 acquisitions in Florida and also had the strongest growth this quarter among all participants in the Medicare Advantage market based on CMS data.
Our growth demonstrates the value for consumers of our Medicare Advantage plans, which includes our focus on benefits popular with seniors and their positive experience receiving well coordinated care from a strong network of local physicians. In total, we increased our Medicare Advantage participation by 85 1,000 seniors this quarter and are serving 340,000 more seniors through the first half of twenty twelve. Our filed 2013 benefits again offer market competitive plans and focused on the benefits that seniors tell us they value most. We anticipate continued steady growth next year as well because of the ongoing entrance into Medicare of millions of seniors, our expanding market presence and the consistently high consumer value our programs offer. Overall, we expect UnitedHealthcare will serve between 1,800,000 and 2,000,000 more consumers this year, making 2012 among the strongest and most diversified membership growth years UnitedHealthcare has ever experienced.
Turning to margins and medical costs. UnitedHealthcare's 2nd quarter operating margin 0.5% remained in line year over year. We expect our consolidated medical care ratio in 20 12 to be in the range of 81.5 percent plus or minus 50 basis points. This is an improvement to our outlook from last November and is based on results from the past 6 months, including reserve development realized to date. We forecast our commercial medical care ratio for 2012 to come in toward the lower end of the range we most recently provided, which was 82% plus or minus 50 basis points.
And we continue to forecast commercial medical cost trends this year at about 6%, plus or minus 50 basis points. Unit cost increases remain the primary driver. Utilization continues to increase modestly. Outpatient usage continues to rise with increases across all markets, commercial, Medicare and Medicaid, all consistent with our last quarter. This is more reflective of an increased number of patient visits and procedures than the more intensive services on a per visit basis.
Some of this increased volume results from our efforts to encourage more appropriate use of health system resources, with patients receiving service on an outpatient basis rather than via full inpatient admissions. Use of physician services is generally stable and inpatient activity remains restrained. UnitedHealthcare's pharmacy costs are again showing the benefits of our intensive management. We will improve these approaches still further as we engage OptumRx to administer our commercial offerings and pharmacy programs. While we're executing well, we remain cautious because pressures on the benefits market remain significant and continue to build.
The commercial sector is competitive. Job creation and new business formation are weak, which impacts growth. Rate pressures in government programs are intensifying and rates in some Medicaid venues are even slightly negative. Unlike prior years, these current Medicaid rate reductions are generally not been mitigated by corresponding benefit reductions or provider fee schedule reductions. We have discussed the funding challenges faced by state programs a number of times and are now more clearly seeing the predicted effects of those pressures in the marketplace.
In the senior market, Medicare Advantage rate increases have been minimal for 3 years or more. Changes to quality star definition that were made after the measurement period was completed will adversely impact rates for many Medicare Advantage market participants in 2013. This backdrop suggests year over year gross margin pressure
in the back half of twenty twelve and into 2013 in Healthcare Benefits.
In this environment, UnitedHealthcare will focus on using new product offerings aligned to more modern consumer engagement techniques that effectively engage our focused clinical programs and high performance networks to achieve growth with fair margins and capital returns. We are also intensely focused on reducing operating costs, becoming leaner, more streamlined and ever closer to the customer. Turning to Health Services. Optum produced revenues of 7 point $3,000,000,000 in the 2nd quarter, an increase of 4% over last year. The Optum Health and Optum Insight businesses posted 21% 16% top line gains respectively with the latter adjusted for divested businesses 2011.
Growth drivers included expansion in integrated care delivery and continued growth in compliance services and clinical and operational performance tools. Our technology and related services offerings continue to show strong market acceptance. With the Optum revenue backlogs again growing more than 20% over last year. This growth was led by strength in data and information infrastructure solutions for government customers, compliance services for hospitals and performance tools for payers. Future revenues will also benefit from the integration of services in the new Medicaid award in Kansas.
In pharmacy services, we are implementing some recent large customer awards, which will modestly benefit second half twenty twelve revenues and we continue to steadily grow specialty drug and Optum's mission is to make the healthcare system work better for everyone. We leverage enterprise level capabilities to drive more effective outcomes, reduce costs and simplify and improve the healthcare experience for all participants across the system. We sized our addressable market at $500,000,000,000 and steadily growing. As a business, we're continuing to create what we call 1 Optum, evolving Optum into a more integrated enterprise, intensely focused on customer needs across the 8 distinct markets we serve. The businesses are lining to deliver the more comprehensive and sophisticated and sustaining solutions customers require in an increasingly complex and changing healthcare environment.
Solutions that bring greater and more is simpler and leaner, more understandable and more responsive to customers. Our Optum cost Our aligning shared services and operational support and administration and removing redundancies that are the historical result of organizing smaller businesses around specific products. When combined with this flatter, simpler organizational approach, tighter alignment enables in an evolution from a product oriented enterprise to one focused on more integrated customer solutions. This opens up opportunities to serve larger, more comprehensive and longer term relationships established with customers at more senior executive levels. Optum's 2nd quarter operating earnings of $320,000,000 were in line with our expectation and improved $68,000,000 sequentially.
We accelerated certain investments this quarter to move faster on integration and better position Optum for future growth. With our first half performance, Optum is on track to deliver full year operating earnings consistent with our projections. 2nd half earnings will benefit from improved leverage from our 1 Optum efforts and seasonally favorable revenue trends in a number of our businesses that are driven by year end business dynamics. We continue to see operating earnings of between $1,300,000,000 to $1,400,000,000 which is modestly above 20.11. This despite absorbing incremental development expenses of more than $150,000,000 in 2012.
We expect to further build on that performance into 2013 and remain on path to doubling Optum's 20 11 earnings by 2015, driven through organic growth, operational efficiencies and PBM Insourcing. To sum up, in a challenging environment, UnitedHealth Group's strong second quarter and first half performance by broad based growth, strong service and execution for clients, continued innovation in products and services, solid margins and positive earnings and cash flows. We want to thank our 100,000 employees for their compassion and their commitment to the people we serve. Every day they're working intensively to deliver dependable, consistent service, innovating and building the capabilities of the future. And their capacities to adapt quickly to changing market remain changing markets remains critical to our future.
As always, we have concerns about today's challenging environment in the health benefits market. These are not new. There continues to be more downward than upward pressure across the healthcare landscape. We expect this environment to prevail for some time due to the employment malaise and imminent regulatory changes. State budgets are clearly constrained for Medicaid.
Medicare funding is similarly pressured, deficit lead policymakers with little room to address long standing funding issues. Long before expansion markets such as exchanges and dual eligibles and broader state Medicaid expansions are fully established and productive, industry regulations and taxes will be imposed and realized. Our diversified position is a strength as we work to address these headwinds, but we have respect for the challenges ahead and believe market expectations should remain in check and aligned to these realities. Based on our results so far, we have increased our 2012 outlook for revenues to $110,000,000,000 and earnings to a range of $4.90 to $5 per share. First half earnings benefited from reserve development as well as the 1st quarter rebate adjustments, while second half results will include TRICARE startup costs.
While we always endeavor to perform to our full potential, we expect earnings per share in the second half to be slightly lower than the first. Longer term, we expect significant market expansion and see opportunities for market share growth. Consumers and benefit sponsors want more for less. At the most basic level, they want higher quality care at a more affordable cost. Consumers have demanded and received more for less in virtually every other segment of our economy and healthcare will not be immune.
Government as a benefit sponsor has been increasingly relying than traditional passive indemnity programs built solely on leveraging fee for service. The commercial market has been consolidating for some time and that trend will continue. To capitalize on the opportunities of the future on a national or even multi market basis, it will be essential to invest in and create leading innovative capabilities and competitive operating cost structures. These have been underlying themes in our businesses for some time. On the Optum side, the market for health services is just beginning to ripen.
Opt in is an early stage enterprise relative to the scale of what we believe will ultimately develop in this sector. We look forward to providing you with a full view of our 2013 aspirations and expectations at our Annual Investor Conference, which will be held in New York City on Tuesday, November 27. I will now turn this call back to our moderator for questions. And again, thank you for joining us
us Your first question comes from the line of Ana Gupte with Sanford Bernstein.
Hi, good morning. Thank you. I was looking, Steve, to get a perspective from you on the consolidation that's ongoing in the government segments and particularly the large transaction that Bellpoint and the Med Group conducted recently? And can you tell us what your thoughts are on strategic alliances versus consolidating more regional players and then more of national sort of broader based M and A play?
Sure. Anna, obviously, we won't comment on specific transactions, but I think I kind of hit it in the end of my formal comments and that is the demands in the marketplace broadly, whether they're in the commercial side the government side, are just continuing to increase, become more sophisticated, more complex. And the responses to them, we think deserve a very focused response and need to be scaled. So we've kind of taken those philosophies in our own business for many years and have focused our responses to those kinds of markets with dedicated business units and have sought to expand them and grow them and build their capabilities. So it is not surprising to see that kind of activity.
We have said that will be coming and it really has been happening for probably 15 years or more. So we as I said in my final comments, we expect that to continue. Now in some respects, we can accomplish those things both through relationships in the marketplaces and alliances and in some instances we have chosen to invest. I think you're going to see both those kinds of responses in the marketplace. And I think both of them can work depending upon the specific markets that you're dealing in.
And then a follow-up on that. So the excess cash flow that you have, if you could provide some perspective on the priorities on health benefits relative to health services and on the benefit side, commercial versus government, then on buybacks and potentially future increases in dividend?
Yes. So again, our financial position remains strong. Our cash generation capacities remain strong. That's really no change from the past. So our approach with respect to capital allocation hasn't changed.
As it relates to expansion activities, we are interested continuing to build on across our business broadly. We look at it not just in market segments also, but in the cultivation of capabilities. So basically all the above is my, I'm sure, unsatisfactory answer to you because we are really interested in building and see opportunities to build in virtually every one of our business areas.
Okay. Thank you. Appreciate
the question. Your next question comes from the line of Tom Carroll with Stifel.
Hey, good morning. Yes, a question on Medicare Advantage. Steve, I think you mentioned steady growth expectations as we've seen in prior years, but that continuing to 2013. But you followed that up with a comment about we've seen rate increases kind of at a minimum for the last few years and that perhaps is going to lead to some margin pressure second half this year maybe into first half of next year. Just maybe pull those two comments together.
Does that suggest perhaps a more aggressive strategy to grow market share, maybe spending a bit of margin here now to perhaps accelerate Medicare Advantage growth over the next, call it, 2 to 3 years?
I'll kind of comment broadly and then let Gail and maybe Tom respond. But I would say one is that environment really isn't any different than the one we've been having for the last 3 years, probably at least. And we really aligned to philosophies around steadiness of managing our benefits and being consistent in the marketplace. And we have historically tried to lean towards the benefits that seniors in specific marketplaces seem to respond to most effectively. I don't think things like that broadly are changing.
We're really just outlining an environment that has prevailed and looks like it is not going to change anytime soon. Do you
want to? Yes. Good morning. It's Gail Boudreaux. A few comments just to build on Steve.
We have, as you know, been dealing with the rate environment in Medicare for a number of years and our focus is on the sustainability of the benefits and the program for consumers. We work hard around affordability, how we work with physicians and hospitals to ensure that we've got the right programs underneath that as well as improving our overall quality. So from that perspective, we've had that strategy for the last few years and we're going to continue to stay focused on that. We think that's really important to the Medicare program overall and think we provide good value. The second issue on growth, we're pleased with our growth.
We've had, as you heard in Steve's opening very strong growth in the SEP part of enrollment as well as a strong opening to the year in AEP. So pleased with the value that we're bringing to the marketplace and in the markets that we're growing. And as you saw this quarter, we also added several acquisitions, which we think help strengthen our position in markets as well as capabilities.
Next question please.
Our next question comes from the line of Michael Baker with Raymond James.
Yes. Thanks a lot. Just a follow-up on the Medicaid comments that you made. Do you think we're close to the point where we'll start see again some Medicaid managed care participants begin to pull out of the market in order to rebalance the relationship between state governments and the private sector? I'll start this and let Gail and Jack mop this up.
But that threat response obviously varies market by market and the posture states take on a vary market by market. But the answer to that is yes, that if we see situations that we believe the state isn't prepared to sustain in a particular market, we will withdraw or as I said in my formal comments, withdraw or reposition the programs. And I think that that discipline has to prevail just like it prevails in other parts of our business. Jack? Thanks, Steve.
Hi, Mike. Just to maybe echo a part of Steve's comments, a successful program between the private sector in any particular state really rests on 2 things. It really rests on a partnership going both ways. And I use partnership in the fullest sense of the word and then really mutually satisfactory economics. And if 1 or both of those aren't missing, then I think we're not doing a service to a state and they're certainly not being well served by us.
If we continue to sort of slog along in relationships that isn't really working ultimately for the Medicaid beneficiary. Thank you. Next question.
The next question comes from the line of Shailesh Golnick with CRT Capital Group.
Good morning. First of all, I just want to clarify something. Nothing in your comments should suggest with respect to Medicaid or any of your other businesses that you're willing to break price discipline even if your margin might be a bit lower year over year. Is that correct?
We are not breaking pricing disciplines across any of our business platforms. Yes. Because on the health benefits side or on the office side.
Thank you. I just wanted to hear you say that because there was an element to that question which almost made it sound like that was the question.
And then Actually, I think we answered that one that we will take the steps necessary if the economics aren't sustainable.
Yes, you did. And my real question is this. I'm fascinated Optum. It appeals on so many different levels from the good business sense to the market opportunity. And I'm curious about what trends or factors you might have seen in the market that tell you that now is the appropriate time to respond in that way and or to lead the customer, whether there's been perhaps a growth in the sophistication that at a pace that maybe is a little bit more accelerated than it might have been a year ago, whether there are fundamental changes going on in the market that and I'm just I guess I'm sorry for the lack of specificity around the question because it's what I'm trying to get at here is there's an issue of United leading too quickly where market can't go.
And so this is a major change. It's a different approach. I think it's the right approach. And I'm curious as to why you think that now is the right time to do this and what types of things you might be able to accomplish by having a more integrated product in transforming some of these relationships and ultimately the way we pay for and deliver care?
Sheryl, I think it's an excellent observation and question. I think I'll have Larry respond, but I would offer a few themes in the onset. As we formulated Optum, brought it in under a single brand, aligned the businesses kind of rebased on them last year. This was basically that market need we saw at that time. So we are really just continuing to execute along those same themes.
And the 1 Optum is a good title in essence that is code across our enterprise for the acceleration of that those integration themes across our business. These have been well laid out and Larry can really run with those.
Cheryl, it's Larry.
I think with Steve's comments as well as Steve's earlier comments when he opened up, I think you kind of know where we're headed in terms of 1 Optum. So let me back up for one second. We decided based on goals that we set that we were trying to go to the 15% ROIC and 6% margin by 2015, which is basically doubling our 2011 earnings that we needed to put together a very strong and focused business plan, 3 year plan. And in putting together that 3 year plan, we are seeing the amount of attention, traction, however, how you want to look at it, that we're receiving from our 8 markets that we're focused on. And as a result of that, we're looking at how we're going to hit those numbers from a performance standpoint.
And as we've been getting into this with our potential customers and so forth, we believe that about 50% of that will come from growth and 50% will come from what I'll call cost management, integration, alignment in the PBM and sourcing. So if you kind of take a look at where we're at today in 2012, we're feeling pretty good that we're in line with expectations. And when we get to what I think one of the questions you were asking is about the markets and growth and so forth. We're seeing that we're in large markets that are getting larger and then we believe that we're starting to really be able to learn a lot and we're going to be expanding as we go forward.
Yes. I think the market is postured for longer term relationships that they're pursuing a broader set of aligned services and seeing the need for that. They're building capabilities and we are building ourselves into them as part of that and they are clearly buying their buying behaviors are moving towards longer term, more sustainable integrated. And what the point I was making before is that probably existed a year, year and a half. So we are urgent about getting Optum this one Optum agenda moving forward because we think the market is already there.
Next question.
Our next question comes from the line of Kevin Fischbeck with Bank of America.
Okay. Thanks. I just wanted to follow-up on some of your comments about pricing into next year. I mean you broadly indicated that the environment was I think aggressive but rational. But the comments around pricing that appears to your competitors appear to be assuming a continuation of low utilization maybe runs counter to how we think about what's rational and certainly my impression of what we were seeing in the last few years.
And then obviously your comments about expecting to lose membership implies that you don't see your competitors as entirely rational. Maybe you can just flesh out some of what you're seeing there. And then also provide some color on markets in particular where you feel like things are maybe more competitive?
Sure. So really, this is around the definition of rational, right? So Gail, you want to
take a shot? Sure. Consistent with the comments we've made over the last several quarters, we expected the market get more competitive and that's what we're seeing. So I would say we're not seeing any change in that. We talk about rational.
Our competitors are making decisions based on their rebate positions, their view of minimum medical loss ratios, their view of future trend. And yes, as we said, I think in the last couple of calls, there are certain pockets where they're making those decisions. But overall, we do see it as rational. When we talked to gave you our guidance last year and what we said in the last several quarters is that consistent with that competitive environment, we are seeing some pressure on our enrollment. You saw that this quarter and you've seen it this year.
So I think that's how it ties to it. We've been very consistent and disciplined in our pricing and that's creating some of that pressure. But we're going to stay the course on that and we're looking at pricing to our future view of trending costs.
And then maybe just kind of follow-up on that into a different product. You mentioned that you expected some rate pressure on the Medicaid side. Obviously, you've seen a lot of RFPs. I mean, how much of what you're seeing, certainly some of your competitors have seen some disruption in states. How much of that disruption is a function of what states are asking for because of their budget pressures or because of the competitive environment from the as far as the bidding process goes from your peers has gotten more competitive and kind of forced people to go to a spectrum they shouldn't be?
I'll let Jack answer that, but I think the budget issues are the prevailing. Yes, I would agree. Hi, Kevin, Jack Larson. So you opened your comments referring to some of the disruptions that some of our competitors had really, it's tough for us to comment on those particular disruptions. We don't actually participate in those programs that have gotten some of the more recent focus.
I would say overall price rates are being pressured probably more so by state budget positions this year and then going into next year. We certainly expect a fair amount of competitive give and take on new states. I think we've priced very thoughtfully on our new wins in Kansas, most recently in Ohio. But I would say overall, it is just the continuing pressure on states trying to make more go farther than they have before.
Great, thanks.
And you really see it aligned to the budget status of the state. That's where you're going to have your problem.
Okay, thank you.
And your next question comes from the line of Justin Lake with JPMorgan.
Thanks. Good morning. Just a couple of follow ups. First on the commercial pricing environment and your kind of outlook for that segment. I I was hoping maybe you could just give us a perspective on this market from a pricing on the pricing side just in terms of the pricing environment today is rationally aggressive.
That's a term we've heard a lot over the years. Can you maybe compare it to what we think of as the last pricing cycle that we saw, let's call it 2,006 or 2,008? Maybe you can just give us some perspective there on how that looked? And then on the commercial cost trends, can you talk us through your cost trends by the 4 segments? And given you lowered your commercial or at least took your commercial MLR target to the lower end of guidance, does that mean that cost trends also coming in toward the lower end there, especially given pricing doesn't seem to be all that great?
Yes. I think with the opening qualifier that the market circumstances and situation of a time is unique to its time. So you really can't say, oh, this is 2000x or 2019 something or other. So I think putting that aside, I think we can offer some comments on that, Gail.
Sure. Justin, your question comparing it to prior cycles, I would look at that the environment is fundamentally different. We're in a different regulatory environment with minimal medical loss ratios. We didn't have that the last few years. And quite frankly, the utilization we're coming out of.
So I don't see it necessarily as comparable to those cycles. Plus, as Steve said in his opening comments, we remained, I think, very respectful of the pressures underlying pressures around unit costs and increasing utilization over time and then the impact of reform provisions as we go through 2013 2014. So from that perspective, we see people making decisions based on their view of minimum MLR rate regulation, etcetera. So that's why we're characterizing this and see it as a rational market, a competitive one but rational. And I guess I'll ask Dan to comment on your questions around utilization.
Market by market. And when you really analyze each market, the activities are not are understandable, right?
Right. Each market has different pressures facing it based on the dynamics of the competitors that are in that market and the products that they have. And we also manage our business very much on a market to market basis, looking at both national trends, but also putting products in those markets that make sense
where we can be competitive. Sure. Justin, Dan Schumacher. To follow-up on your question on cost trends across all three
of our businesses, we've been talking obviously through the balance of 2011 and into 2012 that we were seeing increases in our medical trend, largely due to increases in utilization. And that's coming true and playing out. We're seeing it across the platform. You had also asked about, I think, the relationship of the loss ratio to trend. With respect to our loss ratio on the commercial side, we do expect it to be at the low end of the range that 82% plus or minus 50 basis points.
And our reported loss ratio has a host of factors influencing it. When you look at the trend on more of a core basis, our trend is coming in exactly where we expected and that's at that 6% plus or minus 50 basis points and I would not update that to say anything other than in the midpoint of that
range. Okay, great.
And then just my other follow-up was on the government segments. And you're talking about I think you've taken a more conservative tone on the margins going forward. And I was just hoping you could give us some color in terms of how those businesses are performing in the second quarter in Medicare Advantage and Medicaid, maybe talking either year over year or sequentially just in terms of are you seeing any pressure on those businesses yet or are they coming in better or worse than expected? Just at the moment comment would be great. Thanks.
You bet. This is Dan again. On the Q2, as you look at it as compared to the performance in the same quarter last year,
our government programs in aggregate are performing better. So we have a they're contributing more earnings and they have a lower loss ratio in aggregate. And then as you start to break it into the pieces, our Medicare is actually performing
a little better. Our Medicaid is performing a little
bit worse. And the performing a little bit worse. And the largest contributor to is a little bit more favorable development in the Medicare space.
Thank you. Next question please.
Your next question comes from the line of Carl MacDonald with Citigroup.
Thanks. I was hoping you could elaborate on the comment that you made about the change to the Medicare star ratings after the bids were submitted and the pressure that would put on rates and margins in Medicare Advantage in 2013? Sure. Actually, I think Tom can respond to that most effectively. Sure.
So the as you know, the Medicare program now has a star rating program that includes a pay for performance. And a lot of the performance that we're doing is more futuristic. So we are working today for results in that bonus program that will actually be achieved in 2015. And so when you have that kind of gap in timeframe of performance to actual payment, there can be changes in definitions in the meantime that may change that focus of your performance. And so going into 2013, there was a change in definitions around some of the thresholds or some of the performance measures around the star ratings, which in many situations caused plans across the industry to have a lower performance or star rating than would have been achieved under the previous definition.
Yes. So you're essentially saying that the CMS made the requirements harder or higher to achieve and that's resulting in lower star ratings? Yes. It could have been a change in the level of requirement. It could have been a change in priority for CMS.
Meaning a new metric that hadn't been looked at previously? Change in metrics or change in weighting, right? Yes. Change it likely would be a change in the weighting or an increase in prioritization of a particular metric over another. Got it.
Thank you. Thank you. Next question?
Your next question comes from the line of Melissa McGinnis with Morgan Stanley.
Good morning. Thanks for the question. I believe UNH expected to something like $245,000,000 in total investments related to
I'm sorry. Could you get closer? We can't hear you.
Yes. I'm sorry about that. I believe United expected to incur $245,000,000 in investments for the OptumRx repatriation, Optum broadly in TRICARE and then something like another $215,000,000 in compliance costs. Given this year, given the commentary around some of that being accelerated into the first half, can you provide any additional color maybe just how much of that we've seen in first half versus how much is left to go in second half? And then also beyond that, how much of that we can truly count on rolling off into 2013 potentially providing a tailwind to offset some of the gross margin pressures we've been talking about across the benefits
business? Yes. I would not I think if that had been as meaningful as your question might suggest, we would have responded to it specifically in the formal comments. I think there has been some pull through into the first, but I can't also tell you that we won't continue to try to accelerate because we're trying to go as fast as we can, particularly across Optum. Dave, you want to comment?
I think, Melissa, you may be talking specifically a little bit about the cost of compliance that we outlined at the Investor Conference and then also some of the commentary we made in the Q1 and how that's shaken out. So let me see if I can address this succinctly and then maybe give you a little bit more color. So with respect to the ACA, the law implementation, actually we see those costs accelerating towards the last half of the year, primarily as we prepare for the exchanges and the payment of rebates and things of that nature. So you can expect an acceleration there. Same goes that holds true for the PBM.
As you might suspect, as we get to the kind of the last innings, if you will, in the preparation for that, we're hiring people, we're moving members onto our systems and incurring a lot of the operating costs in those final steps. So you'll see that more towards the back half of the year. Fifty-ten, we're done. We finished that in Q1. We finished clean.
It was a huge success for us. And I think we set the bar for the industry there. ICD-ten is pretty steady. So net net, as you think about these costs of compliance, we're actually we'll see more of those in the second half of the year than we see in the first. Plus, in the Q1, I think we outlined a couple of things.
And these are all really good news. They may sound like bad news in terms of initial costs incurred, but they're all related to the superior growth that UnitedHealthcare has been able to put in place. So for TRICARE, you're going to see a significant amount of operating costs in the back half of the year associated with getting ready for that program. Those will carry over into the beginning part of 'thirteen until we start earning revenue on that case. Medicaid for Ohio and Kansas, obviously those wins are great, but we have to prep and install them.
Same thing with commercial on Nebraska and So all those things really are cost to implement. It's all good news. It may show up as a little bit of a deviation on the operating cost side, but that's good. And then the last thing I'd just remind you on the last half of the year, we're seasonally high in our operating costs, primarily as we get prepared for January and the more intensive medical utilization seasons as well as we get ready for AEPs with staffing and whatnot. So expect overall on the operating cost side, you'll see that operating cost ratio elevate over the back half of the year.
Okay, great. And then just to clarify, as we head into 2013, we talked a little about some of that investment coming out and some ongoing. Is there any way that we can size maybe how to think about SG and A and those investments as a headwind or tailwind into
2013? I think what you're referring to is principally around OptumRx and that is the bulk of those will be incurred in 2012. There'll be some that will go into 2013, but on a comparative basis, OptumRx should step up next year. Dirk? Yes.
I mean, what I would say is that, as you pace into our migration is scheduled to begin on the 1st of 2013 and it paces throughout 2013. We will have sort of operating and training costs ramped up consistent with that migration schedule. So I'd say there'll be a little bit of operating cost, But if you look, the majority of the development costs have occurred in 2012.
Great. Thanks.
Next question, please.
Your next question comes from the line of David Windley with Jefferies.
Hi. Thanks for taking the question. I wanted to ask one around kind of principally Xcel Health and the integration progress you're making there on two fronts. So first of all, I understand that you're using some of their approaches in the more, say, chronic or comorbid portion of your MA book. And I wondered when the benefits to scoring might manifest from that activity.
And then secondly, in the context of Accel Plus and Spiros and EverCare, what progress have you made in kind of pulling those together into an integrated solution as it relates to presentations or pitches in dual eligible opportunities?
I think it's a great question. I would include our Medicaid capabilities in that as well. But Tom, do you want to start? Sure. Hi, David.
This is Tom. And with the integration of XL Health, we're looking at it from 2 approaches. The one that you didn't mention was really around the health plan side of XL Health, so the Care Improvement Plus plans and how we're looking to leverage their focus and their capability and their market presence in 2013, which we definitely took advantage of in our bid offerings for 2013. On the side, you did mention, we are expanding the capabilities around HouseClaus and their integrated clinical care model to a broader Medicare Advantage population with a legacy Medicare and Retirement population. We are showing good progress in that.
The results of that, the work we do in 2012 will be realized on a realized in 2013, as well as the clinical advantages that we get today in identifying early gaps in care from a medical management perspective, we realize those now in 2012.
Okay, super. And then on the from a duals perspective?
Yes. Those same capabilities, again, I think we originally saw the XL capability as it's more geared toward the chronically ill, but I think we are now looking at that differently and we're rolling it out more broadly in the Medicare space, whether you're a dual eligible, whether you're in a more traditional Medicare Advantage program, where you can also benefit from that same house call visit. And so we are incorporating that into our dual eligible offerings as well, wherever the needs really are challenging and the care paths can be most effectively applied. So if I
could follow-up quickly on that. Is it possible to call out which states or perhaps even just quantify the number of states where you think the approach by the state will provide you with the opportunity to really show off your skill sets as opposed to say the California situation that's just going to existing vendors?
Sure. Although, I would say that when you really look at the compelling notion of how these capabilities ultimately align and integrate and the needs of the populations that to be managed, I think all the states will eventually come around. So I really think it's a matter of pacing and whatever factors get it complicate the pacing factor, whether the political or otherwise, I really think that the end of the day, the states confronted with the challenges they have are going to have to embrace these kinds of capabilities and they're better for their populations and they're much better for their programs. Great. Thank you.
Thanks for taking the question.
I love that.
So we're done. Next question please.
Your next question comes from the line of Matt Busch with Goldman Sachs.
Yes. Could I just ask on the Medicaid rate pressures? How does that intersect in your view with the federal statute for actuarially justified rates? Is that a backstop that you can turn to some extent? And if you can give us any geographic detail on the rate pressures, we depreciate it?
Right. So I don't think we're going to offer geographic detail because I think we long term believe that the states will eventually find will be interested in sustaining these programs. The actuarial issue, Jack, do you want to respond? Sure. So as you point out, the actuarial soundness principle is always the backstop each year as states develop and release rates.
I guess I would just make a couple of observations around actuarial soundness. 1, they do provide ranges. And I think we have seen in our community and state business over the years sort of a movement inside those ranges, if you will, from high to low. And I would tell you that we are trending towards the lower side of the ranges most times. And the second thing is around rate pressures.
There's a number of I would say there's a range as to what you assume for managed care savings long term and there is a significant amount of judgment applied to that. And most notably in new state entrants where states are doing their very best to anticipate what managed care savings might be. So those two things are certainly big variables in actuarial soundness, but we're seeing sort of points all in between.
All right. That makes a lot of sense. If I could just ask just one follow-up, a clarification really. As you talked about the cost trend at 6% plus or minus 50 basis points.
I got
a little confused in where you said you're coming in at that on a reported basis, but at the lower end on some other basis. Dan, maybe you could just clarify what you had meant about that?
Sure. Sorry, Matt. Let me try it again. So on the loss ratio on
the commercial side, we expect it to be on the lower end of our guidance. So 80% plus or minus 50% on the lower end. With respect to our trend outlook, full year commercial trend outlook, we're not making any revisions to that. We expect it to be at 6% plus or minus 50 basis points. Wouldn't you expect both of those to go together?
Sorry, maybe I'm splitting hairs too much.
Other issues that affect
Yes.
So I would what I was trying
to get at is there are differences between those things that show up in our reported loss ratios versus how we look at core trend. So I'm saying they're not moving exactly the same. Same loss ratios lower than the guidance. Our trend we expect to be at the 6% plus or minus 5%. Okay.
Okay. I'm clear.
On PennShore, just for one for instance, the rebate adjustment in the Q1 would have affected the loss ratio, but not the core medical trend.
I see. Okay. Fantastic. Thank you.
Thanks. We have time for a couple more questions, but that's probably all. So the next please.
Your next question comes from the line of Christine Arnold with Cowen.
Hey there. If I missed this, just let me know because I had some phone challenges. Payables versus premiums, I know that they can fluctuate a little bit. Were there any timing issues in the quarter on the payables that you'd like to highlight? Because it looks like adjusting for PDP and prior period development, payables didn't quite keep up with premiums.
And then Steve, at your Investor Day, you made some interesting observations about 2014 and how reinsurance and risk adjustment could help to keep small employers from dumping. Can you update us on your 2014 broad thoughts recognizing that we're not in a position to make any specific projections?
I'll do the best I can on that. Dave, maybe you want to comment on the payables? Christine, I've not really seen anything on the payables versus premiums front that's unusual in the quarter other than the fact that we acquired Medicare and Preferred Care and had to put those into our financial statements.
Okay.
And then could you remind me about what specifically you wanted to probe on 2014 that I ended up?
Well, you made some comments about small employers, probably not being incentivized to bump onto the exchange given risk adjustment and reinsurance and also tax advantages? And you had some broad thoughts about how you thought that the structure of the exchanges would protect small groups from dumping and help to protect some profitability there. So I'm just wondering now that we have a little bit more data, not much, but a little bit more and spend some more time studying it.
Probably don't have any more information. And quite honestly, I would say the implementation landscape has probably become more complicated because it's clear that there will be some pacing in terms of how this will be implemented as states have seemed to have more flexibility and the administration seems to be more flexible in terms of how these will go in. But if there is going to be any sector that is going to pursue the exchanges, it's going to be on this very much smaller end. And when you then take a look at that, I think that the pacing of that, if you're a prudent business person, you're not going to necessarily go right to that if you have benefits. It might be those who have not had benefits in the terms of watching how that plays itself out.
You do get tax deductibility on benefits. Your employees are paying 20%, 25% of the total cost of these benefits. So the company is subsidizing 75%. When you begin to go to the exchanges, there clearly will be have to be a relevelling on wages. I think employers will look at that and believe that they perhaps have more control over their benefits than they might have if they lose those benefits and have to make compensation adjustments for healthcare that they no longer control.
I think those when you really get into the heads of the business owner operators that they will be measured in terms of how the responses for those that have benefits and have been committed to benefits in the past. And that's why I think that things perhaps will move in a more measured pace. And I think the implementation now is clearly challenging given the timeframes that we have left. So if there's an update, that's all I'd offer. Gail, how many?
I think Steve hit the key points. The first one, we still don't there's a lot of unknowns still around the exchanges. And 2, as you think about the ranges that many experts have given on dumping from 30% to low single digits, we do think it's going to be at the lower end of that range for the reasons Steve talked about the tax advantage that employers have, the impact of what employees pay right now and the penalty. So that will mute, we think, many of the people moving to the exchanges quickly in the beginning. Thank you.
They may firm up over time, but it will take time. Next question please.
Our next question comes from the line of Josh Raskin with Barclays.
Hi, thanks. Good morning. Can you guys hear me okay?
Yes.
Okay, great. So two quick ones. One, just looking at medical services CPI, there was a pretty big uptick in June. It was driven a lot by the hospital inpatient component. It seems kind of strange that you get kind of a 1 month move like that.
But I'm just curious, are you seeing anything on the hospital pricing side that's different?
Hospital pricing side?
In terms of our negotiations with hospitals, I think we've shared this with you before. I mean, we're coming in, in line with the expectations we set. There's clearly pressure. There's been pressure on the unit cost side. We're moving much more of our payment to pay for performance along a broad continuum.
So, always pressure in the system, but I wouldn't say anything has dramatically changed and we're doing well against the expectations we set as well as trying to move much more of our pay to pay for performance.
Okay. And then just on the 2013 national account front, I didn't hear much. I'm just curious if you guys have a I know it's still a little early, but you guys are probably moving through the Any updates on how the pipeline looks and any sort of initial expectations for Jan 1?
Jeff Alter. Hi, Josh. It's Jeff Alter. So what we've seen over the last few years is that the clients in this marketplace are really looking for a long term partner who can deliver practical innovations like our healthcare cost estimator and our mobility platform, coupled with distinctive service and new models of outreach to help their employees navigate the healthcare system in an easier way. And they're really looking for that long term partner who can manage their benefits and their medical trend, even more important during this time of enormous change.
And we performed really well over the last couple of years with this backdrop. We continue to perform well. We still have I know your question was 13, but we still have over 500,000 members in this space to bring up between now and Oneone hundred and thirteen. And then it is early and we're in the middle of the selling season for 2013, but all indications are that our past success will continue into the oneone season.
Okay. So you guys were up somewhere in the ballpark of $800,000 in the Q1. Is that sort of your baseline run rate target? Or is anything that indicates next year would be better or worse than what we saw this year?
So Josh, we are not offering 2013 guidance today. And so I think we'll I would just say, I think the market our service to that market continues to be strong and we'll comment on 2013 when we get to the investor conference.
Perfect. Thank you. Okay.
Thank you. So I think we should close now. I would hope that you would take away a few key points. First, that UnitedHealth Group continued to deliver strong performance in the second quarter and for the first half of twenty twelve, but we remain focused and realistic considering the challenging economic and market environment we face today. 2nd, we continue to focus on providing consistent value, innovation and dependable execution on behalf of customers and consumers in everything we do.
We remain committed to improving quality and access with while helping to contain the rising cost of care, so that healthcare experience is simpler and more affordable. And lastly, we look into the future, we see markets expanding steadily for health benefits and exponentially for health services. So while we acknowledge the increasing competitive and regulatory pressures ahead, we believe our adaptable diversified businesses are well positioned to grow in the market and that will continue to grow and to prosper over the long term. We thank you very much for your attention today and we'll see you next quarter.
Thank you, ladies and gentlemen. This does conclude today's conference call. You may