Elevance Health Inc. (ELV) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the WellPoint Third Quarter Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to company's management.

[Audio Gap] of our Government Business segment are available to participate in the Q&A session. During this call, we will reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are available on our website at wellpoint.com We will also be making some forward-looking statements on this call. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of WellPoint. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to review the risk factors discussed in today's press release and in our quarterly and annual filings with the SEC. I will now turn the call over to Joe.

Thank you, Doug, and good morning. I'm pleased to report another solid quarter for WellPoint and a continuation of the positive business momentum we have developed across the organization. First, results in the third quarter exceeded our expectations as we reported EPS of $2.16 on a GAAP basis and $2.10 on an adjusted basis. Our performance was driven primarily by lower-than-anticipated medical costs, with membership and revenue also ahead of our prior forecast. From a business line standpoint, operating results were favorable across both our Commercial and Government segments. Second, I'm pleased with our business execution this year as we are now on pace to meaningfully exceed our original goals for 2013 even as we have committed significant time and resources to prepare for the business changes in front of us. Today, we are raising our 2013 membership and EPS guidance, reflecting our strong year-to-date performance and our continued expectation for higher investment spending in the fourth quarter as we begin our implementation of the Affordable Care Act. In Commercial business, our performance remained strong, with operating margins near 10% on a year-to-date basis despite the significant investments we're making in preparation for 2014 and beyond. It is encouraging to be entering 2014 with a diverse base of 28 million commercial members, healthy underlying business fundamentals and solid growth opportunities. We continue to have success in the ASO marketplace and had 2 notable wins in the third quarter. First, the State of Georgia chose us to administer benefits and provide medical management services for approximately 650,000 state employees, teachers, public school employees and retirees in 2014. The State of Georgia had a deep history with Blue Cross and Blue Shield and it is an honor to again serve these customers. We were also awarded the contract to administer hospital and medical health benefits to the country's largest union of property service workers, 32BJ, which is based in New York. 32BJ will benefit from our patient-centered primary care initiative and our Blue priority network to manage cost and improve the health of its 165,000 members. This contract will begin on December 1 of this year. Momentum with larger clients reflects our recent investments in clinical capabilities and a proven ability to drive meaningful health care cost savings. We remain encouraged about the trajectory of our ASO membership and now expect to add at least 800,000 net new ASO members by year-end 2014, or growth of 4% from our year-end 2013 expectation. Our growth on January 1 will likely be even higher than this level, but we expect to continue experiencing some in-group attrition over the balance of the year. We're also optimistic about the growth potential in this market for 2015, as many customers took a wait-and-see approach during this past selling season. It is early, but we believe we can continue to win in the market as the conversation focuses on quality of care and underlying medical cost containment for employers and members. In the fully insured marketplace, the rollout of public insurance exchanges began October 1, and there has been a lot of activity around this area. We remain optimistic about the long-term membership growth opportunity through exchanges. But given that we are just 3 weeks into the open enrollment period, it is really too early to draw any definitive conclusions. Based on what we know to date in our continuing review of the competitive landscape, we remain generally pleased with our positioning across the exchange markets. That said, it will likely be sometime before we can get an accurate picture of what our initial volume on exchanges could be in 2014, and what the resulting risk profile might look like. We note that open enrollment runs through March 31. As has been widely reported in the press, there have been some interface and technical challenges during the first few weeks. The environment is generally consistent with our expectation that the initial phase of implementation would be choppy and involve greater manual workload. We have prepared and invested for expected challenges with the sign-up period as we have thousands of people dedicated to full-time exchange support in locations across the country. One key issue involves the income verification for individuals who are eligible for federal subsidies. This is a necessary step to complete the enrollment process for these individuals, and we support the efforts of state and federal governments to improve the functionality of the exchange technology and streamline the enrollment process. We have a common goal of increasing access and affordability of health care for as many Americans as possible through our collective efforts. We can say that initial interest in exchange products appears robust. As a point of reference, during the first week of open enrollment, we received over 35,000 calls into our service centers, which is more than double our historical weekly volume for individual business. In the second week, this increased to nearly 45,000 inbound calls as consumer awareness began to ramp up across the regions. We continue to evaluate our spending and now have localized TV and radio advertising running in targeted markets, with awareness and outreach efforts also underway through partnerships with Univision, serving the Hispanic community, several retailers, and using social media. Our marketing efforts will continue to be informed by our assessment of local market competitive dynamics and overall federal and state exchange readiness. We will keep you updated on our progress as best as we can as we move forward. Turning to the Government Business segment, we are pleased with results in the quarter, which were driven primarily by benefits from the Amerigroup transaction, as well as improvements in our Medicare business. It is worth noting that our Government Business segment is now generating revenues of over $30 billion annually, representing nearly 45% of our consolidated revenue base, and we continue to see multiple growth avenues in the coming years. In Medicaid, the Amerigroup integration is going well and we're on track to deliver at least mid-teens EPS accretion this year, net of integration cost, with increasing accretion expected in 2014 and '15. We're also pleased to have been recently awarded several new contracts that will drive membership and revenue in the years ahead. In Kentucky, we were chosen as 1 of 3 new plans to serve the Medicaid expansion population in several regions, which we estimate to be around 230,000 people. This contract will also enable us to compete during the state's open enrollment period to serve current Medicaid enrollees in Kentucky. In Florida, we're also pleased to have been selected to serve 4 regions in the Tampa, Miami and Orlando areas as part of the state's managed care program expansion. We estimate there are nearly 1.7 million Medicaid eligibles across these regions for whom we will compete to serve. All of these contracts are scheduled to begin at various times next year. We look forward to serving these new members and remain focused on capitalizing on additional RFP opportunities in the future. While we do not comment on specific RFP activity, there are a number of opportunities on the horizon, and we are well-positioned to continue serving states and their public program beneficiaries. Dual-eligible demonstrations also remain a significant growth opportunity, and our assets and footprint line up well with coming opportunities, including California, New York, Virginia and Texas. We will engage in markets where we see sustainable economic models that allow for appropriate care for these clinically-challenging populations. In addition to the growth we expect from our recent Medicaid and dual-eligible RFP awards, there's also a sizable ramp-up in Medicaid enrollment flowing from the ACA-driven eligibility expansion. We continue to expect that close to half of our Medicaid states will participate in the expansion effective January 1, with other states potentially expanding at a later date. Between the eligibility expansion and our new contract awards, we expect to add at least 400,000 new Medicaid lives by the end of 2014. Moving now to Medicare. Performance was stronger than we expected in the quarter, driven primarily by improvements in our Medicare Advantage business. We are making progress with our Medicare Advantage turnaround efforts consistent with our multi-year improvement and product repositioning strategy. Based on our review of the 2014 competitive landscape, we continue to expect some modest membership attrition next year as we have worked to offset most of the pressures stemming from CMS reimbursement cuts through a variety of levers. We are focused on advancing our Medicare Advantage positioning over time, recognizing that reimbursement challenges will persist into 2015. We continue to believe we have margin improvement opportunities that can help mitigate these pressures. Key strategies include: Continuing to reposition the product portfolio; evaluating markets served; increasing provider engagement and contracting efforts; better capturing risk score revenue; and enhancing our star ratings. These are not mutually exclusive efforts and often build upon one another, between Dick Zoretic, Leeba Lessin and Marc Russo, who recently joined WellPoint to oversee our Blue branded Medicare business, we now have strong and experienced leadership running these programs. We are optimistic about our ability to drive improvement over the next few years. It is important to emphasize that the longer-term growth opportunity with Medicare is compelling, and we remain focused on serving this population with the most affordable and competitive offerings. This includes a diverse array of Medicare Advantage, Supplement and Part D products. Our Medicare Supplement business remains strong and consistent with approximately 840,000 members. And while our Part D enrollment has been under pressure in recent years, we expect to return to growth in 2014 with a more competitive offering in the marketplace. With respect to our outlook for 2014, upon which Wayne will elaborate in a moment, it is simply too early to provide concrete guidance right now given where we are in the exchange implementation process. While our financial goals for 2014 remain consistent with those we shared with you last quarter, our business planning remains ongoing as there are a number of uncertainties related to ACA implementation. We expect that we will be in a better position to provide some incremental commentary around 2014 expectations on our fourth quarter earnings call in January. And I would also like to highlight that we plan to host an Investor Day on March 21, 2014 in New York City. Please save this date on your calendars, and additional details about the event will be forthcoming from our Investor Relations department. Finally, I would note that during the quarter, we further strengthened our governance and oversight with the election of John Short and Liz Tallett to the Board of Directors, both of whom bring extensive health care industry and strategic leadership experience. With their additions, our Board now stands at 10 members, including myself, with 3 of the independent directors having joined within the last 6 months. This level of fresh insight will benefit us as we continue to position WellPoint for the evolving health care landscape in 2014 and beyond. With that, I will turn the call over to Wayne.

Thank you, Joe, and good morning. My comments today will focus on the key financial highlights from the quarter. I'll then discuss our updated guidance for 2013 and our current view of 2014 challenges and opportunities. Please note that the inclusion of Amerigroup business in 2013 results impact the quarter-over-quarter and year-to-date comparison. Overall, third quarter results were stronger than we expected, and driven primarily by lower-than-anticipated medical cost experience, as well as favorable membership and revenue. Our results were also supported by strong operating cash flow generation. On a GAAP basis, the reported EPS of $2.16, which included $0.06 of net income related to the following items: One, a tax benefit of $0.21 per share from a favorable state tax election; two, net investment gains of approximately $0.16 per share, partially offset by the third item, which are expenses of $0.31 per share related to the early retirement of debt. Excluding these items, our adjusted EPS was $2.10, up slightly from the third quarter of last year. On a year-to-date basis, adjusted EPS has grown by 18% from the comparable period of 2012. Medical enrollment totaled 35.5 million medical members as of September 30, down 158,000 or 0.4% sequentially, primarily in the Medicaid business. This was due to the transition of a Healthy Families program to Medi-Cal in California and the expiration of our Medicaid contract in Ohio. While down sequentially, membership in mid-September modestly favorable to our expectation, primarily in commercial ASO business. Operating revenue totaled $17.7 billion, an increase of $2.6 billion or 17% versus the third quarter of 2012, driven by the inclusion of Amerigroup this quarter. The revenue increase from Amerigroup was partially offset by lower Medicare revenue due to the decline in MA membership. Operating revenue in the Commercial segment was up slightly compared with prior year third quarter and also grew sequentially. The benefit expense ratio was 84.9% in the quarter, favorable to our expectation, and down 50 basis points from the third quarter of 2012, primarily due to improvements in the Medicare business. We also saw modest declines in the ratios for our Commercial segment and our California Medicaid operations. These improvements were partially offset by the inclusion of Amerigroup in the current period as Amerigroup carries a higher benefit expense ratio than our consolidated company average and increased benefit expense in the cost plus FEP program. Our commercial medical cost experience has been favorable through the first 9 months of 2013, and we now expect underlying Local Group medical trend to be in the range of 6%, plus or minus 50 basis points for the full year. Our hospital unit cost contracting is running favorable to our plan this year, while utilization has also been lower than anticipated through the first 9 months. Our SG&A expense ratio increased by 80 basis points from the third quarter of 2012, which reflects our investment spending in preparation for the exchanges and other growth opportunities, as well as higher incentive compensation due to our year-to-date operating performance. These increases in SG&A expense were partially offset by the business mix impact of Amerigroup, which carries a lower SG&A ratio than our consolidated average. I would also note that much of the investment spending is being recognized in the Commercial reporting segment, particularly as it relates to the exchange growth opportunity and other new business activity. This factor, along with the normal benefit seasonality we experience in Commercial business, drove the sequential decline in Commercial segment operating gain this quarter. Just a quick comment on the below-the-line activity and the unusual items we highlighted this quarter. Both investment income and interest expense continue to run modestly favorable to our expectations this year, reflecting effective capital management strategies. Additionally, in August, we issued $1.25 billion of long-term debt at a blended rate of 3.6% and used the proceeds to repurchase $1.1 billion of higher coupon debt of various maturities. The early retirement of this debt resulted in an upfront charge of $94 million after tax during the third quarter, but this action will generate interest savings in the future as the debt we retired had a weighted average coupon of 6.1%. We also made a favorable tax election subsequent to the Amerigroup acquisition, which resulted in a $65 million tax benefit in the quarter and had net investment gains of $69 million. Moving on to the balance sheet. For the 9 months ended September 30, 2013, we experienced favorable prior year reserve development of $560 million, which was in line with our expectations. Development was higher than the prior year-to-date period and weighted more towards Government segment in 2013, reflecting the new mix of our business after the acquisition of Amerigroup. We continue to maintain our upper single-digit margin for adverse deviation, and believe our reserve balance remains strong and appropriate as of September 30, 2013. DCP was 40 days as of September 30, down half a day from June 30, 2013 due primarily to the changes in the timing of claim payments between periods. Our debt-to-capital ratio was 37.5% at September 30, down slightly from 37.7% at June 30. We expect this ratio to decline towards the mid-30 range within the next few years. And our parent cash balance was approximately $1.7 billion at September 30, and we expect to end 2013 with approximately $1.5 billion at the parent. We generated stronger-than-expected operating cash flow of $1.4 billion during the quarter, bringing our year-to-date total to nearly $2.8 billion or 1.2x net income. We repurchased nearly 6.5 million shares for $555 million during the quarter. Year-to-date, we've repurchased 15.6 million shares or 5% of the shares outstanding as of December 31, 2012 for $1.2 billion. This is a weighted average price of $74.86. In late September, the Board of Directors authorized an increase of $3.5 billion to our share purchase program, bringing our total authorization to approximately $4.2 billion at the end of the third quarter. We intend to utilize this authorization over a multi-year period. We used $111 million during the quarter for our cash dividend. Our annualized dividend yield is currently approximately 1.7%. Our annualized dividend per share has grown by 50% since we initiated in 2011, to $1.50 today. Turning now to our updated outlook. For 2013, we now expect GAAP EPS of at least $8.45 and adjusted EPS of at least $8.40, both of which are up from our prior guidance. This improvement primarily reflects our favorable medical cost experience, partially offset by higher SG&A expenses as we continue to implement the Affordable Care Act. Our forecast remains prudent in light of the coming market changes and related investments, but we did already incorporate the favorable Q3 results and some positive momentum into Q4 as well. Also, as Joe noted, we've had some incremental wins in the ASO marketplace, now expected in 2013 with approximately 35.6 million members, slightly above our prior guidance range. This forecast also continues to assume some fully-insured membership attrition during the fourth quarter in advance of the subsidized exchange products becoming available in 2014. Our current adjusted EPS outlook represents growth of at least 11% from the $7.56 of adjusted EPS we reported in 2012. We also now expect to generate approximately $3 billion of operating cash flow in 2013. I would also remind investors that the fourth quarter is traditionally our weakest quarter from an EPS perspective, largely reflecting the seasonality of our Commercial products. The timing of our SG&A investment spending will further magnify our EPS seasonality this year. Looking ahead to 2014. While we would typically be finalizing our forward year business plan by late October, our planning for 2014 is more complicated due to the ACA implementation and remains in process, given that we are just a few weeks into the exchange open enrollment period. As such, it is too early to provide specific EPS guidance for 2014, but we do want to offer some general thoughts on our goals. To reiterate what we said on our earnings call last quarter, we continue to target EPS above $8 for 2014, which will be challenging. While today, we've raised our 2013 adjusted EPS guidance by $0.40 or 5%, and we are encouraged by our third quarter operating performance, we caution against run-rating this improvement into 2014 given the number of changes to our business due to ACA implementation. These include: Exchange enrollment. As Joe described, it is simply too early to get an accurate picture of our exchange-based volume or risk profile. This impacts our assumptions around both new membership coming into the market from the uninsured, as well as a potential migration from our existing lines of business. Group member retention. While it appears the risk of employer dumping in 2014 will be lower than we originally thought 12 to 18 months ago, our retention will be impacted by the exchange rollout and competitive dynamics. Our estimates in this area will likely continue to evolve over the next few months. Then finally, SG&A expenses. As our view on membership volume continues to evolve, we will refine our SG&A forecast. We will continue to tailor our investment plans to the opportunities we see across our markets and we'll adjust our plans if they are not supported by adequate returns. Other headwinds and tailwinds to EPS in 2014 include the following: Some potential headwinds include: The insurer fee. We are generally having success reflecting this fee appropriately in our Commercial products, but we continue to be cautious about the timing and non-deductibility across our Government program. We expect this to drive an increase in our effective tax rate next year. Medicare. We continue to expect a modest headwind in Medicare Advantage, as Joe discussed earlier, and medical cost trends. The favorable experience we've seen this year may not recur in 2014. Some anticipated tailwinds include our membership growth. We remain comfortable with our assumptions for growth in the commercial ASO and Medicaid businesses, both of which reflect our strong value proposition and improving capabilities. Collectively, these areas could add at least 1.2 million new members by year-end 2014. Amerigroup accretion. We continue to expect increasing accretion in 2014 due to the non-recurrence of onetime integration cost and growth in the underlying business. And finally, share count, which will be lower next year due to our share repurchase activity. Also, not a headwind or tailwind from an earnings perspective, but an item impacting operating revenue comparability in 2014 will be the conversion of our New York State account to ASO. This is a 1.1 million member, very low margin experience-rated account that will become self-funded on January 1. This will adversely impact operating revenue by approximately $2 billion, but have a negligible operating gain impact and therefore, enhance our operating margin. We will plan to provide more commentary about our 2014 expectations in January with incremental details likely to come at the Investor Day in March, by which time, we expect to have better visibility into the initial results for our ACA implementation. We expect 2014 will bring both challenges and opportunities, and we will continue to invest with an eye towards driving cash flow and value creation over the next several years. I will now turn the call back to Joe to lead the Q&A session.

Thanks, Wayne. With that, operator, please open the queue for questions.

[Operator Instructions] Our first question will come from the line of Josh Raskin from Barclays.

Question, I guess, just staring with the exchanges, and certainly understand that it's too early and appreciate some of the commentary and color around the calls and stuff like that. But I guess just from a timing perspective, are you guys starting to see actual enrollment coming through? I know you've got some state-based exchanges, but you also have some of the Fed exchange as well. So are you seeing some of those application process -- processed applications coming through? And maybe, when would you get a better sense as to when you'll know what your membership and selection will look like?

Great. Josh, thanks for the question. Let me first share with everybody, again, that I've got our 2 presidents with us today who oversee the divisions that are engaged in many of the activities we've discussed already this morning. One being Dick Zoretic, the President of the Government Business division; and the other, Ken Goulet, President of Commercial & Specialty. Specific of the question, obviously, Ken is intimately involved in the development and rollout of our exchange engagement, so I'm going to ask Ken maybe to speak to this question in a moment. But let me just underscore that we're very optimistic about the long-term membership growth opportunity. And again, we're just 3 weeks into this process. And as Wayne has often said on the calls, it's a lumpy experience, and I think, in fact, it's proven out to be exactly that. Based on what we know to date in our continuing review of the competitive landscape, we believe we're very well-positioned as the enrollment process matures. We believe we see a lot of interest in the exchange products. It's a very robust engagement with a lot of call-ins to our call centers. So I think that gives us a very, very strong cause for optimism. As you know there, it's a fairly elaborate enrollment process in terms of establishing a profile for the individual, the subsidy eligibility for the individual, the planned design, and then completing the application, et cetera, et cetera. So there's a lot of so-called administrative backdrop that goes to this. So in many regards, I think at least we have always anticipated the lumpiness, and so the administrative process, I think will work itself out. And again, we seem optimistic. Ken?

Yes. So Josh, the -- as Joe said, very optimistic about the opportunity in front of us, and the initial interest in call volume has been very high. It is different on how we'll track it by state and by the federal programs, which is about a 50-50 split for us. And in the states, we start getting 834 enrollment files in November. It varies by state, but we'll get initial reads in November. We are getting conversations and know where we're positioned, but there'll be some specific information coming through. On the federal exchange, right now, we are getting enrollments and we have individuals signed up. We do, as you've seen widely publicized, there are some challenges going through the application and enrollment process, but we have a feel for -- initial feel, but we're not providing numbers right now because it's just working its way through the system. I would just re-highlight, we've been working on this for a couple of years now. We knew that there would be some choppiness going in. We've hired bubble staff, we have a number of folks ready to assist our customers, working through the issues, and we're not at all surprised by the initial activity. I would highlight, it's a 6-month enrollment process. The reason it's 6 months is because there is an education process necessary and it's going to take some of our own marketing efforts as well as a greater awareness by the public. So I do feel that there will be continued enrollments right up through March. And just like Medicare D, there'll be more people signing up towards the end of the program than early on in the program.

Okay. That's helpful. And then just a quick follow-up, I know, Wayne, you've spoken in the past about passing on the insurance fee in your Commercial book sort of ratably as your members renew for those that have member months in 2014. And obviously, you guys have a relatively large individual and small group book. So I'm just curious, have you guys actually seen any benefit from the industry fees, sort of pricing component in your products already in this year being that you haven't actually paid the fee?

Josh, some of the fee is being baked into the current year numbers, although I will tell you it's a fairly small number relative to the size of the fee that we expect our business to pick up. I would say, in fact, it's probably south of 10% relative to the fee we expect for next year. That being said, we're having good success in passing on the fee relative to pricing. There's been an education that we've been walking through. But as we also commented on though, the bigger concern that we want to make sure investors are aware of, and our investors in particular, is the non-deductibility component of the fee and the challenges that are there that Dick and his team are working through. And it might be worthwhile for Dick just to at least comment on this briefly on the Medicaid side.

Yes, thanks, Wayne. So just to summarize at a high level, we've obviously had a lot of conversations with all of our states about the fee. And I would say, in general terms, most states have indicated that they're willing to cover the fee itself in our rates. Now we haven't seen all those rates yet, so obviously, there's a lot of numbers yet that we have to have put in front of us. But those conversations, largely, have been encouraging. As it relates to the lost tax deduction, the way I would characterize the situation is that most states have acknowledged that issue. They understand it's real for us. But fewer states have confirmed at this point that they will actually incorporate the lost tax deduction into our rates, than have confirmed that they will incorporate the tax itself or the fee itself into our rates. So we're still in dialogue. It's still early. I'd point out that 6 months ago, we didn't have a lot of confirmation that the tax would be covered and we made progress there. But I would say our outlook, as we said in our prepared comments, is cautious at this point. And I think the other point that's worth noting is that, even if we get confirmation from states that they're willing to cover the lost tax deduction, there's the question of the timing of the confirmation and when we'll actually be able to take credit for that financially, if you will, in 2014.

Got you. And is it fair to say that the tax-deductibility portion is somewhere in the ballpark in any given state, 40%, 45% of the total fee, grossed up?

Yes, yes. That's a good proxy on a gross-up basis.

Our next question is from the line of Kevin Fischbeck from Bank of America Merrill Lynch.

Okay, great. I just wanted to follow up on the membership numbers for this year, the higher number. Is that just simply related to the New York contract win? I know that last quarter, you talked about some concerns around some attrition heading into healthcare reform. I wanted to see if that assumption had changed at all?

Kevin, it's Ken. I'll address that. We were pleased with the addition of the New York account which was quite sizable and helped us through last quarter, but there is also a stabilization of the other businesses. One of the items going in with some of the challenges of the Affordable Care Act is that this is holding some other people to just, more or less, a wait-and-see attitude, see how things go, so we are not seeing some of the other attrition that we felt may occur going into the last quarter of quick-and-early shoppers. So we're a little bit more comfortable with our fourth quarter numbers.

Okay. And so to the extent that you're not seeing that attrition or movement in the population for -- so does this mean then that you feel that you've locked in more of your membership then for 2014, so you're renewing people through next year at this point instead of seeing them drop-off and looking to buy in the exchange later? And if that's the case, how do you think about how that will impact your 2015 business? Have we just kind of delayed what could be the margin hit into 2015? Or do you feel that, that membership that will convert in 2015 is generally going to be a good risk pool, so it's going to be moving into and creating a more stable environment for 2015 on the exchanges more broadly?

Yes. Kevin, I would say that because individual and small group makes choices late, I wouldn't say there's as much locking in yet, although the early responses to our early renewal process has been favorable, and has been more favorable than we expected. That generally is better risk and it delays part of the potential margin compression. But we have all channels open. We have the exchange channels, the private exchange channels, our small group and we actually have transition plans for each of our customers and try to work them through it. So we're happy that the early renewal programs working for us and for other carriers, and there seems to be an interest. It's not fully locked in yet. I think decisions get made more in the November and December time frame for individual and small group where the majority of the early renewal activity is. But we're pleased with the way our communications have gone, the way we've executed the actual offerings and are able to help our customers through the decision process. Thank you.

Do they have -- do you have any stats on how much has been renewed through next year at this point versus kind of still open at this point?

I would say it's still open. I would say the initial conversations and the initial flow is positive, but I'm not going to give specific numbers right now.

Our next question is from the line of Christine Arnold from Cowen.

Kind of moving forward because I know a positive -- you've been saying a positive 3% to a minus 5% is kind of the range of potential kind of a reasonable case versus worst-case scenarios for exchange margins. Are you still comfortable with that range? And how do we think about how we're going to be booking this in the first half of next year? Do you feel like you have enough kind of accounting guidance and enough data to book the 3Rs? And what do you worry about versus not with that margin potential changes?

We're still comfortable with our margin range of 3% to 5% based on the pricing we've put forward and what we have out there. I think the accounting question of 3Rs is an important one. One of the things we have some degree of comfort on though is that based on the size and scale of our book of business, we ought to be able to come up with a reasonable actuarial, at least, perspective of what we think the outcomes would be, and we will have a -- at least a base line assumption. Albeit, it will probably be conservative because of the unknowns, but we think we can have at least a reasonable statistic position to take on the 3Rs. The other thing I would like to highlight too is when you think about the risk adjusters, it's somewhat created on a curve, right, and ultimately risk pools are going to be dependent upon what each party gets. But both on-exchange and off-exchange is going to be subject to it and with the size of our individual and small group book business we have today, we have we think a unique opportunity to begin risk coding and have begun risk coding already on our existing book so that we can position ourselves to at least get to a point on the curve that hopefully either breaks even or makes us a net beneficiary. And again, we'll probably be conservative on our outlook, but nonetheless, we think we can have a position by next year.

And is the worst case scenario, as you guys think about it kind of a minus 5 or is that not even on the table anymore? Or did I misinterpret that in prior communications?

I think our perspective was that the 3Rs protected organizations to up to about a 5% loss. That was kind of our best estimate. Again, there's so many moving parts, who's playing, how they're playing, what price points they come in, but I think at least based on the way we read the law today and on our own nothing more than a mathematical exercise at this point, we think that it generally caps losses if you had a bad market at around 5%.

Okay. And what have you assumed in the $8 at least? Last question, sorry.

Well, again, I think as we said -- are you referring to 2014, Christine?

Yes, exactly.

I think our goal is just still try to target guidance with an 8 handle for next year, but we want to get through some of the challenges and opportunities that still lie ahead of us. The exchanges are so meaningful to the impact not only on enrollment but around mix between small group and individual, that it's really hard for us until we can get a little more data, say, over the next 2 to 3 months to really firm up that position. But I would say our goal is still to target guidance next year with at least an 8 handle.

I'm sorry, maybe I didn't ask it very well. When you target at least 8% -- $8 a share next year, are you assuming that 3% to 5% target margin or more like a breakeven? What's embedded in that since it is a meaningful assumption?

Yes. I think we should wait till we get more membership. And again, I can understand the mix profile better. And again, it's one of many of the challenges that we're talking about that we need to get better data on before we can conclude at this point.

Our next question is from Justin Lake from JPMorgan. Justin Lake - JP Morgan Chase & Co, Research Division: First question on investment spending. Can you give us an update on where you are this year versus that $300 million target you had discussed previously? And thoughts on how much we should think about as being one-time going into next year.

I would say, at this point, Justin, we still have the full $300 million. Part of that have been spent obviously in the third quarter, and we continue to anticipate the majority of the remainder being spent in the fourth quarter. So we have not adjusted our outlook for any of that spending. One of the challenges we have is around the marketing dollars, and we have in the $70 million to $100 million range, still forecasted for the remainder of the year as it relates to the exchanges. And ultimately, when we spend those dollars is really a function of when the functionality of exchanges are working at the level that allows the consumer to get to the exchange and ultimately, buy -- hopefully, our product. And so those dollars are one of many variable factors that affect not only our current year, but also affect next year. Because again, we anticipate spending those dollars, it's just a question of when will the functionality be there to allow us to more aggressively deploy those dollars with membership attributed to it. So, Justin, probably not the answer you're looking for, but just recognize, our anticipation is we will spend those dollars this year though with the revenue attributed to next year, but those could lead into next year, which means on a comp basis, it could affect, ultimately, the year-over-year comp on how much spending happens this year versus next. Justin Lake - JP Morgan Chase & Co, Research Division: And any thoughts on the Medicaid and Medicare spend this year versus next? I think those were also about $100 million each?

I'd say the spending there, first of all, in the Medicare side, is giving us the benefits we had anticipated. Some of that spending does curtail next year, but some of that spending on the Medicare is to offset some of the headwinds associated with the rate pressures for next year. And then on the Medicaid side, we really like what we continue to see in the book on Medicaid. We really like the growth that's there, and we actually don't think the opportunities will decline next year. If anything, there'll be reasons to continue to invest at that level and possibly more based on the revenue opportunities in late '14, early '15. Justin Lake - JP Morgan Chase & Co, Research Division: Okay, great. And then just my follow-up is on the Commercial business. As we think into -- your trend is obviously doing better. As we think into '14, can you give us an idea of how you're pricing your commercial risk book versus that 6% cost trend? And then also, any kind of early thoughts on the early renewal process that you were focused on for the individual and small group book?

So Justin, it's Ken. We did price for the trends that we anticipate. And we anticipate a bit of a trend uptick year-over-year. We priced for that in the disciplined pricing approach -- that we talked with our regulators and were able to discuss trends in each of those markets and agreed to what they would be. So we are anticipating a slight uptick, and we have priced for it in the 50 bps range. I would say, on the early renewal -- as mentioned earlier, the early renewals are really the better risk groups, so you're locking in better risk but at a revenue that pricing trend in about what I had just mentioned. We are going out with early renewals with anticipated trends built in and allowing customers to make a choice, of which is the best direction they should go, retain the current plans with a trend going forward or select amongst the metal plans that will be offered.

Our next question is from Chris Rigg from Susquehanna.

Just want to follow up on the cost trend question. You noted in the press release and spoke very briefly on the unit cost side. Can you give us a sense for what you're seeing there, and what you think might be able to continue going into '14 and beyond?

I would say that one of the items that we have an opportunity to influence is obviously the cost component of our cost of goods sold, specifically our negotiations with providers in the hospital systems. We are seeing a very tremendous success candidly in the current year. It's a big portion of our underlying run rate that we're seeing. In some ways, a bigger portion in the utilization trends that we've seen to date. I don't anticipate our success there being muted in the future, though I think that we have a very strong proposition for the provider networks out there. We can really help them in this new world of garnering market share and revenue. And we continue to have success in our negotiations. That being said, there's a shared responsibility in this new world for both us and our partners to find ways to make the product more affordable. And we're very pleased with what our partners are doing to assist with that. And it's one of the reasons you'll see even with areas like Part D that we're going to have a much more competitive product for next year than we've had historically, that really all of our partners are working to drive affordability.

This is Joe. I might add that we've developed some very solid relationships with the provider community, particularly around value-based payment methodologies. We're finding a lot of interest in sort of a payment reform approach that truly rewards for a value creation. As an example, we have now in excess of 50 ACOs, various kinds of models and forms that we would put in place. But again, a very, very strong cadre of provider systems that are actively involved in value-based payment streams. Our primary care model is growing at a very, very good clip, and so we've got a tremendous number of physicians that are participating with us in these value payment methodologies. So you put it all together, I think there definitely is a momentum push occurring, that is very, very tangible, and I think will lead us into '14, '15 and beyond with some very unique methodologies for controlling unit costs. I don't know, Ken, if you want to add anything through that given you've been working directly with the provider groups.

I think you covered it very well. I would say we also have over 720 hospitals on the hospital pay-for-performance system, which is a shared partnership. And we are spiking out our pay-for-value areas. There's such an interest, and I think because of our market share and because of the way we have a lot of feet on the street working with our providers that this is accelerated. I think with Joe here, it's given a good perspective for all of us on hospital and provider side, how best to build partnerships and it's a key strategy over the next few years.

Our next question is from Matthew Borsch with Goldman Sachs.

Just wanted to ask about -- a little more about the pricing environment. I'm curious what you're seeing from competitors, and if there is maybe more divergence in the way some competitors are pricing for next year as compared to what you might have seen, let's say at this time last year. And related to that, maybe you could just comment on -- I think you said you've been generally successful at putting through the industry fee, and I assume that, that includes the tax deductibility impact, which sounds like a little bit of an improvement because I recall earlier, you'd indicated the tax deductibility part and the commercial pricing in some cases was more of a challenge.

So Matthew, I'll address it and I would like to address it -- it's Ken. I would like to address it from an on-exchange and an off-exchange basis for competitive environment. So first on the off-exchange or kind of the traditional pricing. I would say a couple of things. One, it has remained disciplined for us and generally disciplined across each of the markets. Second, there is some divergence, I would say, as we recognized a year ago as MLR impacts tied in that, that can change a specific carrier's pricing for a specific market. And I believe because of the early renewal strategies as well, there are some divergent areas from a market-to-market basis, but not really material. I would say if I looked across our markets as a whole, still very disciplined pricing and positioning works well. We have been a little bit more successful in having the tax deductibility built in just as we talked with regulators over the last 6 months. I would say it is a state-by-state discussion and impacted state-by-state. We and, from what we can see our competitors, in specific states, were able to put the -- recognize the impact of the taxes. For the on-exchange, we're generally very pleased with our positioning across most states with the strategies we've built out and the segments we're looking at. I would say it's -- we have good data going in, so we feel we're pretty well positioned when we make pricing assumptions. And there are some -- there's a wider variance on the on-exchange. There are certain markets that have a wider variance than you would expect. I would stake Colorado as a good example amongst our markets. The pricing on a metal level between the highest and the lowest competitor is pretty varied in Colorado. We're more towards the middle of the pricing spectrums and I would just say, I believe we have found in a few particular markets that there's a wider variance than there was expected to be. Now that will work itself out in the next year or 2 as experience runs in and assumptions play out. But on-exchange, more variance; off-exchange, very similar to the past few years.

Just one follow-up there. As you think about where you've had to do a lot of work to get the industry fee and the tax impact reflected in pricing. Has that been more of a push on the small group rate filings with regulators or equally as much in your employer-to-employer pricing with the middle to larger risk groups?

On the -- I would say it requires discussions, negotiations and just knowledge on both on the middle to larger group. It's easier to point out and to have a good discussion, but those groups are also very competitively priced, and you need to have a good end pricing point. As you highlight the tax implications, there is an awareness and a very clear discussion around it. But ultimately, it is a little bit more price sensitive and market competitive. On the small group, it is a regulator-by-regulator discussion. There is awareness and I would say more acceptance by some than others, but we had very clear and open conversations about the impact and the need to be able to include it for sustainability of our products.

One item I do want to add, though, for our investors, though, to keep in mind is that even our success in markets or lack thereof of passing on the tax. It's still relevant to the fact that you have to win the member to have the ability to actually pass on the tax and the non-deductibility of it. And so ultimately, it's important too though, that we not price our product at a level that causes us not to be successful though in attracting those members. Because again, it's very important that we have the member to have the availability, and then pricing becomes somewhat fungible, whether it be trend or the tax or the gross-up of the tax. So again, I do want to highlight, as Ken said, this is very surgical, it's very market-by-market, and it's very important that we evaluate the tax and the non-deductibility relative to the ability of maintaining or growing our membership.

And our next question is from Dave Windley from Jefferies.

So I wanted to look at your -- or go back to your comments on the Amerigroup integration. I believe when you talked about tracking ahead of plan, I wondered what your longer term views were, for example, dollar of accretion in 2015. Is that still your view or given experience so far, would you expect better than that? And how does the transition of the PBM in 2014 impact that as well?

Two things I would highlight on the accretion. One is, it is tracking slightly better than our expectations in '13. Probably more importantly though is, some items are tracking in our perspective slightly slower for '14 and '15 which is the pace of duals. And while we're happy with the success of the wins we have to date, I would say those are actually tracking slower than our expectations when we did the acquisition. That being said, Dick has done, I think, a tremendous job redeploying those resources into the WellPoint Medicaid book. And so we think we will be able to achieve the value we laid out in the original transaction, and some of the value that we thought would come in sooner is being offset by other opportunities. But nonetheless, I think we'll get the value long-term.

Okay. Moving on, I think, Joe, you've talked about attacking the IT spend number in WellPoint, which is a pretty big number. And I wondered what progress you had made in your strategies around digging into $1 billion of IT spend and shrinking that?

Yes, great. David, I appreciate the question. I'm going to specifically answer it. I'd like for Dick though to go back to the Medicaid question for a moment because he's intimately involved in the states. There's a lot of movement in state and some degree of unpredictability in terms of when they're in. So Dick? And David, I'm going to come back to your question because it's a very important question.

Well, I guess, I take the spirit of your question is being kind of how is it going, and my comments would be as follows: We've been pretty focused on investing in the fundamentals of the business since we arrived. What we found in the WellPoint book of business was a book that had a lot of opportunity for improvement just in terms of executing better on the basic blocking and tackling of the business, and that's what we've been very focused on. And in some cases, that requires putting more boots on ground, if you will, in certain markets to do the basics of the business and we've been at that now for a number of months and in some markets at least we're starting to see a little bit of progress in the underlying run rate as a result of those efforts. So we're -- it's so early, but we're encouraged by that, and it boosts our confidence that we're on the right path and we should just continue to stick to our knitting, if you will. Obviously, we're very focused on the integration itself and we've made a lot of headway there just in terms of bringing the 2 organizations together, creating a common management team, getting everybody grounded in the principles that we want everyone to pursue. And I'm gratified that by and large, the key leaders that we wanted to retain in the organization, both on the legacy Amerigroup side and the WellPoint side of things have stayed and are, in some cases, have been repositioned into broader roles and are performing at a very high level. So we're pleased about that. We're also very focused on growth. We've had a number of wins that we're pleased about, most notably Kentucky, Florida and earlier win in Texas. Wayne commented on the duals. Relative to where I think the industry thought the duals would be a year ago, things are moving at a slightly slower pace, but nonetheless, the opportunity remains significant and we think we're very well positioned. When we look at our assets, the legacy Amerigroup assets relative to managing the long-term care services, just the combined Medicaid presence that the 2 organizations have created and then all of our capabilities on the Medicare side, both with our Medicare Advantage presence and the inclusion of CareMore and their ability to manage the needs of the high-risk population, we don't think there's another company out there that has a better collection of assets than we do to compete and manage the duals. It's really just going to come down to a question of, do the economics in each of the markets that we're looking at makes sense? And we're looking, as we mentioned, at California, Virginia, New York, and Texas primarily and the financial equation in each one of those states is a little bit different, but nonetheless, we think we're well positioned and we think even if we don't play in every market, there's still a lot of growth associated with the duals and the markets that we do play in. And then finally, we're prepping for Medicaid expansion in 2014, and we're excited about that. So that's sort of the big picture answer to the question, how is it going? I think you also asked about the PBM. We are working with ESI at this point on a transition which will, at this point anyway, is assumed to commence in the middle of 2014. There will be a change in cost associated with our pharmacy program as a result of that transition per the contracted rates that we have with ESI, and we've been working with ESI to fashion customized networks, pharmacy networks, at the local level in each state to sort of deal with the cost impact of that transition. So we think at the end of the day, we're to going to wind up still being quite competitive as we have in the past and we'll provide further updates on that question as time goes by.

Okay. And David, you asked about IT, I'll give you a very quick response. We are in a very sort of a deep dive analytical process examining our IT infrastructure. And actually, it's a 2-part equation. One is what I would call piping. And we're examining the lights-on cost for our IT systems. Obviously, if we can pare back some of that expense it allows us then to reinvest for the future with respect to information management, which is the other part of the equation, specifically around reporting and analytics. We feel we've got a tremendous opportunity there to vastly improve our efforts in that space so that we can be responsive to the needs of the marketplace, especially the provider community that are looking for expert reports and analytical abilities to help them better manage care. So my sense is that probably by Investors Day, we'll have a lot of clarity around our IT spend, and hopefully at that point, we'll be able to share some more insights with you.

Our next question is from the line of Carl McDonald from Citigroup.

Great. On the exchange strategy, if I can generalize for you, it seems like most of the markets, you're sort of middle of the pack in terms of pricing. You don't have the smallest network on the exchange, but you do have a smaller subset than what you'd have in your normal commercial products. Now that we've seen your strategy and what everybody else has done, just be interested in the thought process that you used to get to where you are relative to maybe a lower cost option on the exchanges.

Carl, it's Ken. And I would say, you're doing some pretty detailed research, but it is a market-by-market impact. I would say, in general, our strategies were -- we were going to focus on products that our customers want and price because price would be important, but brand also does have at the consumer level, an impact. Our general strategies were to narrow our network and focus on our formularies, as well as have products that are appropriate products that our customers would want. When we look at our pricing, we went more towards -- on the state and federal exchanges trying to move products more towards the price point, so it was more geared to the bronze and silver, and we feel pretty comfortable with where we're positioned. There are -- most of our markets, we're very happy with where we are positioned, and we feel that brand will carry our membership and the early results are too difficult to tell, but we do seem to be pulling in the membership on a brand basis. There's a deep affiliation to the Blue brand. And then in a few markets, we are not positioned exactly where we wanted to be. We're higher and we need to recognize whether that is mispricing by competitors or whether we need to drive further changes into our products and networks for next year. But we do feel very comfortable with where we ended up. It's about where we expected to be. We did feel that we wanted to grab some market share, but we were going to be disciplined in our pricing to get there.

And I'm sure the answer to this is also a market-by-market. But just be interested if there was anything that you saw from competitors that was a big surprise to you, more on a national level than anything you're seeing in one specific market?

Carl, it's a good question. We generally don't, of course, comment about competitors. I would say you can check through the filings to see where certain -- are positioned or about how many markets are playing in. But I would say that no general surprises, although there are some trends you can look when you compare carrier-to-carrier and how they priced.

And our final question will come from the line of Scott Fidel from Deutsche Bank.

Just -- first question, just wanted to ask about some of the data that Connecticut had put out on some of the early enrollment trends in their exchange and granted very early here, and the enrollment was very small so far, but they did cite that the majority of the enrollees coming in were ages 55 to 64. So just interested whether that data is correlating with what you're seeing in Connecticut and whether you think that's more of an anomaly or whether there's potential we could see those types of trends in other markets.

Scott, it's Ken again. And I would say, it's generally what we had expected. So let me give you the reasoning behind it. But I would say the Connecticut information has not been shared formally though. They'll be sharing their membership files with us in November, and it is preliminary, but we've had conversations and tied into it. So I'd first say that, it's pretty well documented, the time and the process used to go through the application process and enrollment. And therefore, the individuals that sign on early are going to have a higher acuity or be older and looking for coverage if they were unable to get affordable coverage previously. We expect to receive the actual enrollment files from the state in November, and we'll be able to analyze the business more in detail at that point. But I would say, the Connecticut numbers, if you look at them as reported, it was about 3,800 enrollees that were reported on. Half went to Medicaid, half went to the exchanges and 2/3 of the enrollment went to us or about 1,200 members. And that's just too small a membership number to draw any conclusion on. But based on our simulations, and we did over 58,000 simulations, to prepare and understand consumer behavior. We did see that the older would choose sooner, they're more interested, they're more likely to purchase gold in part because they're more risk averse and in part because of the higher actuarial value they're seeking. So there's no surprise in the numbers. What it does indicate, and what Wayne stated earlier is, to get the right risk pool, we need to do marketing, we need to pull people through the exchanges, we have planned for that. Our business and implementation control centers are ready to dial that up when appropriate, but we're going to get a better risk pool and the right risk pool as we market through a variety of channels, which include telesales, our broker support, direct mail, Internet purchasing and our search tools. So we have a number of activities that we'll be able to pull the membership in.

Okay. And then just as of my follow-up maybe for Dick, if you could just give us an update on, I guess, the perennial question of how the duals rate negotiations are going in California. And are we moving closer to resolution there? Or are there still some major obstacles there in terms of an agreement between the state and the plans?

Well, first of all, I'll say my ability to predict the answer to this question has been weak in the past, so I'm not sure I'm going to able to give you a great answer today. But we are moving closer, I will say that. There's obviously been a lot of back-and-forth between us, as well as the other players in California and the state, as well as CMS on the rates. There's probably more work to be done on the Medi-Cal side of the rate equation than the Medicare side of the rate equation. I'll say that much, and we're hopeful that we'll wind up in a good place when all is said and done. We very much want to participate in the program. Strategically, I think it's important not just for our company, but for the industry, and frankly, the nation as a whole. I mean, this is the highest cost portion of the Medicare program and the Medicaid program that we're talking about, and it's the least managed. And this is the first time that the states and CMS and the industry have come together to create a program to do exactly that. And as I said earlier, we have great assets and we think those assets can make a big difference for California and every other state, as well as the Medicare program. So our intent is sincere in that we want to play, but the rates have to be adequate at the end of the day. And if they're not adequate, we'll move on and we'll play elsewhere where they are.

Thank you. And I would now like to turn the conference back over to company's management with any closing comments.

Thank you for your questions this morning. In closing, let me reiterate our key takeaway messages today. We're pleased with another solid quarter performance. 3Q results were better than we anticipated and continue the operating momentum we have established across the organization. We're raising 2013 membership and EPS guidance, which reflects our strong year-to-date performance and our continued expectation for higher investment spending in the fourth quarter as we begin our implementation of the Affordable Care Act. Exchange rollout has started, but it is too early to draw conclusions. Initial interest in the exchange products appear very robust, but there have also been some interface and technical issues, as well as other considerations that have been reported in the press. This is generally consistent with our expectation that the initial phase of implementation would likely be choppy. We continue to work with state and federal governments and support their efforts to improve the enrollment process. Based on what we know to date and our continuing review of the competitive landscape, we remain generally pleased with our positioning across the exchange markets. Our 2014 planning remains in progress. I know we've gotten a lot of questions today about our outlook for '14. I must underscore, it's simply too early to provide concrete guidance for '14 right now given where we are in the exchange implementation process. While our financial goal has remained consistent with those we've shared last quarter, our business planning remains ongoing as there are a number of uncertainties related to the ACA implementation. You can expect more information on '14, early in '14. We plan to provide more commentary about 2014 expectations in January with incremental details likely to come at the Investor Day in March, by which time we expect to have better visibility into the initial results of our ACA implementation. Our Executive team is committed to a three-pronged attack regarding these matters, specifically: consistency of practice, prudent decision-making and an execution focus that's necessary to win. I have a sense that we've certainly communicated a lot of those characteristics today, and I'm hopeful that as we get into '14, we'll be able to demonstrate it even more precisely. I want to thank everybody for participating in our call this morning. Operator, please provide the call replay instructions.

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