Health Net Inc. (HNT)

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Health Net, Inc. (HNT)

Q2 2013 Earnings Call

July 25, 2013 11:00 am ET

Executives

Angie McCabe - Vice President of Investor Relations

Jay M. Gellert - Chief Executive Officer, President and Director

Analysts

Joshua R. Raskin - Barclays Capital, Research Division

Sarah James - Wedbush Securities Inc., Research Division

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Justin Lake - JP Morgan Chase & Co, Research Division

Ralph Giacobbe - Crédit Suisse AG, Research Division

Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

David H. Windley - Jefferies LLC, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Ana Gupte - Dowling & Partners Securities, LLC

Christine Arnold - Cowen and Company, LLC, Research Division

Brian Turner

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

Carl R. McDonald - Citigroup Inc, Research Division

Presentation

Operator

Good morning, everyone, and welcome the Health Net, Inc., Second Quarter 2013 Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to Angie McCabe, Vice President of Investor Relations. Please go ahead.

Angie McCabe

Thank you, Kyle, and thank you all for joining us for a discussion of Health Net's second quarter 2013 results.

During this call, we will make forward-looking statements that are subject to certain risks and uncertainties. Risk factors that may impact those statements and could cause actual future results to differ materially from currently expected results are described in our filings with the SEC as well as the cautionary statements in our press release issued in advance of this call.

In today's call, we will refer to adjusted days claims payable. This adjusted metric is not being presented in accordance with Generally Accepted Accounting Principles, or GAAP. Please refer to today's press release, which is available on the company's website, for a reconciliation of this non-GAAP financial measure with the most directly comparable GAAP financial measure, days claims payable.

I will now turn the call over to Jay Gellert, Health Net CEO. Jay?

Jay M. Gellert

Thank you, Angie, and good morning. I'm pleased to report on our continuing strong operating performance in 2013 and our preparations for our key new business opportunities next year. In the second quarter of '13, each line of business improved sequentially, helped by ongoing favorable health care cost trends. Commercial, Medicare and Medicaid improved quarter-over-quarter. We expect to sustain our current performance in the second half of 2013.

Our strong operating performance gives us the flexibility to make necessary investments in our future. These investments include preparing for: One, the exchanges; two, the California Coordinated Care Initiative, which includes the dual demonstration; three, Medicaid expansion from the ACA; and four, our entry into Arizona Medicaid. These investments and the impact of reinstated Medicaid premium taxes caused us to raise our G&A guidance. I'll cover that in more detail in a few moments.

We are adjusting our GAAP earnings per diluted share guidance to $2.10 to $2.20 to reflect the second quarter severance costs. Our full year combined Western Region and Government Contracts EPS guidance of $2.20 to $2.30 exists despite the higher G&A expenses.

Let's now look at the second quarter highlights.

I want to first speak about the improvement in our commercial book. Last year, we laid out a very clear plan to reposition the commercial book away from unprofitable, full-network, large-group accounts to smaller accounts and tailored network products. We believed that this plan would improve the MCR. The plan is working and produced the intended improvement. In the second quarter of 2013, the commercial MCR was 84.9%, 380 basis points better than the second quarter of 2012 and 100 basis points better than the commercial MCR in the first quarter of 2013. Recall that we did have adverse prior-period development in 2012 second quarter. In the second quarter of 2013, we had no adverse prior-period development.

The premium yield-to-health care cost spread was positive 430 basis points in the second quarter of this year after being negative a year ago. Given the wealth of 2014 opportunities we have, we continue to price in a disciplined manner. With this in mind, we are maintaining our commercial premium yield-to-health care cost spread guidance for the balance of '13.

As part of the effort to reposition the commercial book, we did anticipate membership attrition. Commercial enrollment has declined by approximately 8% year-to-date within our overall guidance range for the full year of 2013.

The key to our commercial enrollment story continues to be our tailored network products. At the end of the second quarter of '13, our tailored network products account for more than 37% of total commercial enrollment, up from approximately 35% at the end of the second quarter of '12. Our tailored network momentum got a new boost in the second quarter as CalPERS selected Health Net's tailored network products as part of its offering to members in '14. We are seeing more interest in tailored network products in the large accounts segment, where such products have not historically been a significant factor.

Let me make a brief comment about our Government Contracts segment. We noted when we announced our first quarter '13 results that we expected significant improvement in the pretax contribution in the second quarter of '13. That's what happened as Government Contracts contributed approximately $18.1 million in pretax income in the second quarter. We now expect the full year pretax income for 2013 to be approximately $55 million to $60 million, somewhat lower than prior guidance due to certain adjustments under our TRICARE contract.

Let me now turn to Medicare. The Medicare Advantage MCR did well in the second quarter of '13. It improved by 210 basis points compared with the second quarter of '12. We're encouraged by the favorable Medicare health care cost trends, particularly in physician and outpatient services. We expect the Medicare Advantage MCR to be close to this level or even better through the second half of '13.

Let me make a brief comment on our MA proposals for next year. We approached '14 in much the same way that we approached '13. We focused on achieving reasonable margins and gaining enrollment in specific geographic areas where we have more competitive health care cost structures.

Medicaid did well in the second quarter of '13, as moderating health care costs contributed to MCR improvement quarter-over-quarter. This sequential Medicaid MCR improvement was significantly influenced by California's reinstatement of Medicaid premium taxes on June 27 as part of the new state budget. The taxes were retroactive to July 1, '12. This resulted in our recording $35.7 million in premium tax expense on the G&A line in the second quarter of '13. In addition, the state increased premiums by the same amount, so there's no impact on the bottom line. The increased premiums, though, did benefit the Medicaid MCR by 510 basis points in the second quarter of '13. The Medicaid premium tax effect caused the G&A ratio to be higher in the second quarter, at 11%. The $35.7 million in premium taxes amounted to approximately 120 basis points. We currently expect taxes to continue for 3 years starting July 1, '13.

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