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Transcript of and Question and Answer Portion of Aetna Inc. April 25, 2002
Analyst Call
ADDITIONAL INFORMATION; CAUTIONARY STATEMENT: Aetna's 2002 Proxy Statement was
filed with the Securities and Exchange Commission on March 18, 2002 and mailed
to Aetna's shareholders on or about March 20, 2002. Aetna filed additional
participant information with the SEC on April 4, 2002. Aetna's shareholders
should read these materials, and all additional materials that Aetna files with
the SEC, because they contain important information relating to the 2002 Annual
Meeting. In addition, certain information in this presentation is forward
looking. Forward-looking information is based on management's estimates,
assumptions and projections, and is subject to significant uncertainties and
other factors, many of which are beyond Aetna's control. Important risk factors
could cause actual future results and other future events to differ materially
from those currently estimated by management. Those risk factors include, but
are not limited to: unanticipated increases in medical costs (including
increased medical utilization, increased pharmacy costs, increases resulting
from unfavorable changes in contracting or recontracting with providers,
changes in membership mix to lower-premium or higher-cost products or
membership-adverse selection; as well as changes in medical cost estimates due
to the necessary extensive judgment that is used in the medical cost estimation
process, the considerable variability inherent in such estimates, and the
sensitivity of such estimates to changes in medical claims payment patterns and
changes in medical cost trends); increases in medical costs or Group Insurance
claims resulting from the aftermath of the events of September 11, 2001 and the
continued threat of terrorism; the ability to achieve targeted savings from
work force reductions and to otherwise reduce administrative expenses in light
of significant membership reductions being experienced in 2002; the ability to
maintain targeted levels of service, and improve relations with providers, as
well as operating performance, while making significant staff reductions and
taking actions to reduce medical costs; the ability to successfully implement
Aetna's new customer model approach; lower levels of investment income from
continued lower interest rates; adverse government regulation (including
legislative proposals to eliminate or reduce ERISA pre-emption of state laws
that would increase potential litigation exposure, and other proposals, such as
the Patients' Bill of Rights, that would increase potential litigation exposure
or mandate coverage of certain health benefits); adverse pricing actions by
government payors; changes in size, product mix and medical cost experience of
membership in key markets, particularly given the significant membership
reductions being experienced in 2002; and the outcome of litigation and
regulatory matters, including numerous purported health care class actions and
ongoing reviews of business practices by various regulatory agencies. For more
discussion of important factors that may materially affect Aetna, please see
the risk factors contained in Aetna's 2001 Report on Form 10-K, on file with
the Securities and Exchange Commission. You also should read Aetna's 2002 first
quarter Form 10-Q when filed with the Securities and Exchange Commission for a
discussion of Aetna's historical results of operations and financial condition.
OPERATOR: One moment please for the first question. Joshua Raskin with Lehman
Brothers, you may proceed with your question.
JOSHUA RASKIN, LEHMAN BROTHERS: Hi, thanks, and I guess first and foremost
congrats on the quarter. Quick question I guess on the MLR improvement, if
there was any way if maybe Ron, you could sort of flesh out the components of
the improvement - maybe a quantification of how much actually came from member
lapses, how much of it was due to yields well above cost trends et cetera? If
you could sort of flesh that out, that'd be helpful.
R. WILLIAMS: Yes, the point you made is that in terms of the change in the
lapses, basically the high MCR cases, that was worth about 1 point to us in the
overall process, then we had the degree to which we had the spread between
premium yields and medical trend as reported in the quarter, and that was
really the principal source of the balance.
RASKIN: So that was the remainder? And then could you just remind us how much
of the book renewed on January 1 and your expectations for that spread
throughout the rest of the year?
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R. WILLIAMS: Yes, for the risk business, we had about 53 percent renewed in the
first quarter, 15 in the second, 21 in the third, and about 11 in the fourth
quarter.
RASKIN: OK. And you would expect that that spread of your premiums over cost
will continue based on your expectations that you outlined earlier.
R. WILLIAMS: Yes.
RASKIN: OK. And then just one last question on the MLR for the Medicare book of
business, seemed obviously a lot lower than you had seen and really a lot lower
than what we're seeing industry standards, and I guess the suggestion in the
outlook was that that would rise back into the 87, 88 percent range for the
full year. You know, any expectations about sort of where we're going to see
that trend in the second quarter and going forward? Is there sort of some
sequential improvement that we would expect or is that just, you know, benefit
design changes and deductibles and premiums?
R. WILLIAMS: Well, I think the principle sources of the change came about,
there were some significant plan design changes that really will be in effect
across the entire year. We also believe that there was a little bit of effect
from lower utilization, partly as a result of the fact that it was a somewhat
milder winter and we think that that may possibly have shown up. But beyond
that, we expect that it will pretty much be across the quarters.
RASKIN: OK. So it doesn't sound like there's anything that necessarily drove it
lower in the first quarter other than, maybe some seasonal...
R. WILLIAMS: Well, we did mention a few minutes ago that there was a prior
period, a fairly minor, positive development from the prior period, it's about
4 cents.
RASKIN: OK. That's helpful. I'll get back in queue if I have a follow up.
Thanks.
OPERATOR: James Lane with Salomon Smith Barney.
JAMES LANE, SALOMON SMITH BARNEY: Hi. Good morning I was wondering if you could
contrast the Company's approach to the rating actions - the work that was done
before the rating actions and the rating actions that were taken for the
January 1 renewals, relative to the January 1 of 2001 renewals to sort of
address the obvious concerns about the ability to show progress in the first
quarter, the changing nature of your business when you have as much business
come off and potentials for anti-selection? Anything tangible you could give us
to help, you know, address those questions would be helpful. And then I have a
follow-up.
R. WILLIAMS: OK. Let me try to answer the question here as best I can. I think
that we made very important changes in our underwriting and rating practices.
And part of those were to really begin to apply back to the basics of
fundamental and appropriate underwriting discipline, in terms of understanding
the risks that we were underwriting. We looked at our rating approaches, as we
talked a lot in prior calls about some of the ways in which we felt we were not
appropriately rating our cases. We let customers select what type of
contract-type they wanted to be rated on, a single or two-party or a family.
They got to choose that.
Some of our rating areas were aggregated as opposed to being disaggregated. We
actually participated in a lot of option business in the very small end of the
rating end of the spectrum, cases in the two up to 50 range, where you really
want to be the whole case in that area.
There were just a whole host of kind of back to the basics of fundamental
underwriting that we worked in the last half of 2001 to get in place in order
to accurately price. And part of it was really pricing discipline. It was
really making certain we did our best to understand our costs and that we
priced appropriately in order to make certain we were pricing ahead of our
medical cost trends.
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LANE: OK. Thanks. And sorry for asking an over-simplified question, Ron, and I
know it's a complicated answer.
Secondly, I was just wondering if you could tell us what you view as the
biggest contributor to the more moderate cost trend that you saw in the
business that did renew and what the outlook for that particular contributor
might be over the course of the next two years? Thanks.
R. WILLIAMS: Well, I think that I would say that we've had a host of actions
that we have put in place that have impacted this. One of those has been to
focus our contracting activities on things like reducing our exposure to
variable costs. We talked in prior calls about initiatives we had related to
improving our cost position in radiology by some of the radiology initiatives.
We worked on our lab cost structure. We put in place a lot of patient
management initiatives, in terms of enhancing our case management programs,
making certain that we put in place on-site nurses. So, there are just a whole
host of initiatives, including things that we looked at around plan design.
We put in place our disease management programs, things like congestive heart
failure, diabetes. And we think all of these things, in conjunction with
efforts we've been making in the pharmacy area, are showing up.
LANE: Thank you.
J. ROWE: If I can add, just add a comment also Jim to that? This is Jack. I
think that going forward, you asked about what we think about going forward.
And I would say two things. One is, I think, that we've not seen the benefit of
the disease management programs. We're really putting them in place, so that
while they're there the differences that you see now don't yet reflect any
traction from them. So that's something that you'll start to see significant
improvements next year and maybe going forward, both in terms of as the
programs get established and as we increase the number of programs.
And I think a second one is that, I think we're all focused on trying to use
information better to help patients make informed decisions. We believe that a
consumer-driven system will emerge over time. And I think that that has the
potential to also be a mitigating factor for trend if we can solve that puzzle.
LANE: Thanks.
OPERATOR: Bill McKeever with UBS Warburg. Please go ahead.
BILL MCKEEVER, UBS WARBURG: My question has to do with membership. You
mentioned you were down to 15 million. Do you think that from here you're
stabilized or do you expect further culling in the second, third quarters, et
cetera?
R. WILLIAMS: Well, we are forecasting approximately 14 million at the year-end.
And that's on the basis of continuing our pricing discipline that we've
outlined and which has resulted in the improvement that we've seen. On the
offset, as we've indicated, we do feel like we are very focused externally on
the market. We're beginning to experience some wins in the national account
market. We're working diligently to improve our market presence in the middle
market. And we're working actively in small group to begin to appoint more
producers and expand our distribution system there.
MCKEEVER: OK. Just one last follow-up question. In terms of the trends that
you're seeing, in terms of employer preference for various products going more
self-funded or PPO, just what are your sort of overall thoughts there?
R. WILLIAMS: Well, I think, we do see particularly large employers are
continuing to express some preference for self-insured arrangements. We also do
continue to see employers participating in buy-downs, I think I mentioned
250-300 basis points approximately in benefit buy-downs. So employers are
looking for plans that have more cost-sharing features. I mentioned also that
our Aetna Health fund product
3
has had a lot of very positive feedback in the market. We think it's an
emerging trend and it's one we're committed to focusing on and we've seen an
enormous amount of sales activity and interest, at least, among employers in
that product.
MCKEEVER: Thank you.
OPERATOR: Ed Kroll with S.G. Cowen. Please go ahead with your question.
ED KROLL, S.G. COWEN: Good morning.
My first question's on the tax rate. Alan, I think you said 32 to 33 percent
for this quarter and for the full year. As I look at your income statement, the
consolidated, it looks more to me like 29.7 percent.
A. BENNETT: Yes, that's the influence of the nondeductible goodwill on the tax
calculation. If you take the amortization out of the calculation and redo it,
you'll find what our true effective tax rate is.
KROLL: OK. So then, I guess that would be the same thing for the full year -
the full year with that goodwill affect, if you will, would be in the high 29s?
A. BENNETT: On the analysis you're look at, it would be. But our effective
rate, once you make the adjustment I just spoke of, it would get you right back
in my range.
KROLL: OK. And is that, so the 32-33, if that's good for this year, is that
your normal tax rate, would you say, going forward?
A. BENNETT: That would be the tax rate for this year based on that level of
income. As our income grows, the rate may go up a little bit too, since some of
our tax planning items are fixed in dollars so that it wears off a little bit
as your income grows.
KROLL: Ok. Then quickly, a follow-up. On the cash flow, thanks for the detail
there, on a GAAP basis with those balance sheet adjustments you mentioned, is
it minus 117? You used 117 million on a GAAP basis because of those one-timers,
is that right?
A. BENNETT: Yes. It would be 117. Actually, when you look at our 10Q, it'll be
higher because the 10Q actually considers changes to LCP insurance reserves as
well, which we don't consider when we give our call. So it actually will be a
larger number than the 117. But the 117 is a GAAP number, excluding LCP.
KROLL: And what is the LCP number - just order of magnitude?
A. BENNETT: Large Case Pensions would increase that by about 100 million.
KROLL: OK. Thank you.
OPERATOR: Michael Stanski of Tudor Investments.
MICHAEL STANSKI: Hello?
J. ROWE: Yes, go ahead.
STANSKI: Two questions. One is, the rating agencies downgraded your debt
recently. Can you talk about your plans to go back to them? And also, what is
the cost of debt that you're enjoying right now? Second question is, decisions
on the PBM piece of your business to out-source or spin it out, please.
4
A. BENNETT: Great. First of all, with respect to the cost of our debt. The debt
now is - 100 percent of our debt at the balance sheet date is fixed. So it's
the blended rate of high sevens percent range. We have no commercial paper
right now, although we will be in the commercial paper market from time to
time.
J. ROWE: With respect to our PBM, we feel that our PBM could be more
effectively utilized to serve our customers than it has been in the past. And
we are in the middle of a detailed strategic analysis of what components of it
can be most effectively linked with our health business in a more coherent
package. It's one of several assets that we have. Our Intellihealth Web site,
our medical informatics capacity, USQA data warehouse, et cetera, are others
where we really feel that we need to be much more aggressive in tying these
assets together and reaping the benefits. We haven't made any final decisions
about the strategy yet, but we expect to by mid-year or so.
A. BENNETT: Just to follow up, another point you mentioned was about the rating
agencies, going back to the rating agencies. And we have a regular dialogue
with them each quarter, we'll continue to do that. It's hard to speak for the
actions that they would have. I hope they would view our results as favorable.
I want to make one comment too on the debt. I mentioned that $1.6 billion of
debt is fixed. We did enter into a swap in the fourth quarter of last year for
$350 million of that debt which actually makes that portion of our long-term
debt float at short-term rates.
STANSKI: Thank you.
J. ROWE: Thank you.
OPERATOR: Frank Mogavero with Atlantic Asset Management.
FRANK MOGAVERO, ATLANTIC ASSET MANAGEMENT: Hi. So I understand there's no debt
outstanding under any of your credit agreements. I just wanted to see where you
stood in relation to whatever covenants they have. What is the, as of the end
of the quarter the required minimum level of shareholders' equity and also
where do you stand relative to the total debt to earnings test?
A. BENNETT: There are coverage tests that we are well above on EBITDA at the
quarter, very comfortably within EBITDA.
With respect to our total equity requirements, again, we are well above that.
We actually had provisions in our covenants to write off up to 4.5 billion in
good will. We wrote off less than 3 billion, so we've got that as a buffer. So
we're well within both of our covenants.
MOGAVERO: Could you provide the number that, you know, that you have for that
minimum; and also what EBITDA is for the last 12 months?
A. BENNETT: I'll get those information - hopefully we'll have that by the end
of the call.
MOGAVERO: OK. Great.
OPERATOR: Roberta Goodman with Merrill Lynch.
ROBERTA GOODMAN, MERRILL LYNCH: Thanks. Can you hear me?
J. ROWE: Yes.
GOODMAN: OK, great. Question for you on the benefit buydowns. I was wondering
if you could discuss the nature of the buydowns and how you would sort of split
out that 250 to 350 basis points in terms of those components. You know, how
much is deductibles, how much is copays, co-insurance changes, you know, and
what's actually covered, that kind of thing.
5
R. WILLIAMS: Yes. I think, Roberta, I would characterize it generally and say
that what we're seeing is that employers are increasing deductibles, both in
the office visits both primary care and in some instances specialty. They also
are moving up the copay spectrum as it relates to pharmacy and three-tier
copayment. And then we are beginning to see increases in deductible where we
have PPO plans and we've introduced some co-insurance features in our HMO
plans. And, what an employer does depends very much on the geography, the
competitive situation and the regional preferences. But the one thing we see
universally is people are moving up the spectrum.
GOODMAN: OK. And in terms of breaking it down, you couldn't really do that. I
guess it's probably a little too complicated.
R. WILLIAMS: Yes. I just don't think it would be something we could do for you
today.
GOODMAN: OK. And also you had mentioned service improvements. Could you give us
some of the metrics on that? You discussed service quality and claim
submissions and so on.
R. WILLIAMS: Yes.
GOODMAN: So I was wondering if you could put some numbers.
R. WILLIAMS: Yes, we have a series of metrics that we look at. And I think one
of them is probably the time we spend going out talking to customers, convening
with them, getting their kind of perspective, do they believe that service is
in fact improving from their perspective.
The things that we typically look at are things like our phone wait times, the
degree to which our first claim resolution numbers are increasing. That's a
metric we use in which we look at the percentage of claims that are paid on a
first pass through the system and do not require resubmission. It's really a
measure of our own efficiency and also a measure of our degree to which we're
educating the provider community on how to submit claims accurately the first
time so that they can be paid. We've seen some increases there over the past
year.
We look at the fundamental indicators - first claim resolution, turnaround
time, call wait time. We see all these indicators moving in the right
direction.
GOODMAN: But can you give any specifics?
R. WILLIAMS: For competitive reasons, we probably wouldn't want to talk about
that today.
GOODMAN: OK. Thank you.
J. ROWE: Thank you, Roberta.
OPERATOR: Charles Boorady with Goldman Sachs. Please go ahead with your
question.
CHARLES BOORADY, GOLDMAN SACHS: Thanks. Good morning.
First, of the 17 percent premium yield, can you say how much came from lapses,
mixed change and market exits versus a same-customer average increase that you
put through?
R. WILLIAMS: Well, I think what I would say, Charles, is that when we go back
and we look at the business that lapsed in the first quarter we saw that there
was a kind of a 1 percent difference in the MCR, the net effect on the MCR of
the lapse of those cases. So that's part one.
I think the balance of the effect came about principally as a result of pricing
in excess of our claim trends.
6
BOORADY: What was, if I just look at a same-customer basis, what was
approximately the average premium yield put through for a same customer?
R. WILLIAMS: For the first quarter itself?
BOORADY: Yes.
R. WILLIAMS: Yes. The first quarter yield was about in the 19 to 20 percent
range.
BOORADY: Great. OK. Separate but related, do you know approximately what the
medical cost trend was experienced by your self-funded customers again on a
same-customer basis?
R. WILLIAMS: Our data indicates that the self-funded base of customers are
approximately in the same range, obviously modified for their book of business,
their geography, the demographics of their population.
BOORADY: Same as the PPO?
R. WILLIAMS: Yes.
BOORADY: OK. Great.
R. WILLIAMS: And the same as the HMO.
BOORADY: OK. Just a final question. If I could. You've in the past mentioned
that you believe you could ultimately get your margins to be in line with your
major competitors, can you give us an update on your thoughts there and give
us, if you could, a target pretax margin based on who you see as your main
competitors, where they are right now? Obviously industry margins have been
improving quite a bit.
J. ROWE: Well, Charles, our goal of substantially expanding our pretax
operating margins, which you recall well, during 2002 and 2003 is really not
changed. Our progress this quarter represents a significant step toward that,
obviously, and we were seeking an operating margin in the 6 percent range by
the end of 2003.
You've mentioned some recent changes in our competitors' outlooks, and with
respect to that I would say, at this point our visibility into 2003, Charles,
is obviously not as great as some of our competition because we're in a
turnaround, with the challenges of a new operating model. We've got three
months experience with it.
As we go forward through this year we will have substantially more experience
with it, we may be able to further refine and modify those goals. But at this
point our goal remains to have an operating margin in the 6 percent range in
terms of our operations at the end of 2003.
BOORADY: Meaning - implying that it's a full year '04, it's reasonable to
expect that 6 percent would be a good full year minimum in '04, but during '03
you would progress up to the 6 percent mark by year end?
J. ROWE: That's how I wish I had said it, Charles, right.
BOORADY: Thanks.
OPERATOR: John Rex with Bear Stearns. Please proceed with your question.
JOHN REX, BEAR STERNS: Thank you. Alan, I was wondering if you could just go
back to the comment you made about your outlook for net G&A reduction. I want
to make sure I got that right. You
7
said $300 million pre-tax G&A savings. And then did you say that that was
offset by the increase in pension insurance costs?
A. BENNETT: Yeah. I'm glad you brought that up. Let me clarify that our goal is
to really cut $400 million in pre-tax and then the $100 million would bring
that down to a $300 pre-tax net.
REX: OK, great. And then also, could you tell us how much of your December
charge for your severance charge that you used in the quarter and do you
anticipate any additional charges for severance, needing to take additional
charges for severance during the year?
A. BENNETT: Ok. The first is that for the first quarter we made $40 million of
payments against both the December 2001 and December 2000 charges. So that was
$40 million of cash that went out against those reserves. With regards to the
full year SG&A savings, of the $400 million gross number that I'm talking
about, the $300 net - of the $400 million, $200 million will come from the 2001
severance action.
Now, I'll clarify that. With respect to future charges, our cost reduction
review right now is a very comprehensive review. We know that we're making a
good down payment on cost reductions. Our first quarter SG&A for example
sequentially dropped $77 million from last year, which is 7 percent, but our
membership dropped 12 percent, so this is really increasing our focus in this
area. But I think it would be premature at this point to talk about severance
actions. We're too early in the process for that.
REX: Thank you.
J. ROWE: Thank you.
OPERATOR: Joshua Raskin with Lehman Brothers, please proceed with your
follow-up question.
RASKIN: Just one real quick question in terms of the reduction in amortization
expense for 2003, Alan, if you could just quantify that.
A. BENNETT: Yes, the 2003 amortization is around $38 million.
RASKIN: And what is that compared to for 2002?
A. BENNETT: $85 million.
OPERATOR: James Lane with Salomon Smith Barney, please proceed with your
follow-up question.
LANE: My follow-up question is regarding non-risk membership. I believe at the
fourth quarter conference call, Ron, I think you indicated that the net 100,000
life addition that you did add was more of a function of conversion from risk
to non-risk, and that in the absence of that, I think the non-risk membership
would have been down.
I was wondering if you could - is that correct? And secondly, maybe give us a
little bit of color on what you see going forward? In the absence of
conversion, would you also expect to be a net market share gainer? Thanks.
R. WILLIAMS: Yes, when we look back at the first quarter, what we saw was that
the actual ASC membership in total was just down very slightly. I mean, it was
essentially flat, would be the way I would characterize it.
I think, as we look forward, we do believe that we will be, over time, an
increasingly important player in the ASC market. As I mentioned, we see
significantly more activity in the national account market in the form of
proposals. It's obviously too early to comment on what we believe is going to
happen in total for 1/1/03,
8
but we do see a good level of activity. We think we're well positioned,
particularly for the large multi-state clients who are typically attracted to
this funding type.
LANE: Thanks, and just as a follow-on very related to that, do you see any
change in the key things that are driving the RFP processes? We've heard in the
marketplace that the customers are becoming a little bit less sensitive to the
base fees and becoming a lot more cognizant of the discounts that you can get
them off of provider list prices.
And sort of if that's consistent with what you're seeing, and maybe some
comments on how, if that's the case, the Aetna products compare in the
marketplace.
R. WILLIAMS: I think what we're seeing is that customers are focusing in on the
impact of the collection of services on medical costs, and clearly, discounts
are one of the things that is an important part of that.
But they also recognize that when you look at the distribution of the
utilizers, there are a small number of patients who really incur most of the
medical costs, and they are looking at health plans in terms of the ability for
them to effectively manage those patients through catastrophic case management
programs through other forms of patient management, the ability to provide the
patients with critical information that they're interested in and also in the
disease management area.
So I think we are seeing a strong interest on the health care costs, but in a
broader context than simply discounts.
LANE: Thank you.
D. OAKES: Operator, I'd like to give Alan Bennett a chance to clarify an
earlier question, and then we'll take one more caller following that, and that
will be it.
A. BENNETT: Good. Just to clarify the question earlier on debt covenants, there
are two covenants. One is a minimum equity calculation, which is 4.4 billion is
the minimum, and that's disclosed in our financial - our 10Q's. And the second
calculation, which is not specifically disclosed anywhere, is an EBITDA
calculation which essentially takes net income and adds back some non-cash
events and allows us to exclude certain charges that are defined under the
contract.
That is a four-quarter rolling calculation, which, again, we don't disclose,
but we due have a comment in our 10Q and 10K's that say we met the EBITDA
requirements. I hope that clarifies those two covenants.
D. OAKES: Thank you, Alan. Last question.
OPERATOR: Our last question will come from Ed Kroll with S.G. Cowen. Please
proceed with your follow-up question.
KROLL: Thank you, just to follow up on the tax rate and kind of loop it in to
your earnings guidance. So you're guiding to a $1.25 to $1.35 for the full year
this year? And that assumes that 32 to 33 percent rate - or I guess the way I
look at it, slightly below 30.
A. BENNETT: The way you look at it would be that way, right. But if you take
the amortization out and recalculate it, the guidance I gave, of 32 or 34
percent would be accurate.
KROLL: OK, great. And then one other thing, on the balance sheet, the retained
earnings reduction, that's strictly related to the goodwill impairment charge?
If you look at 12/31 versus 3/31?
A. BENNETT: The reduction also included some unrealized losses of securities
that run through comprehensive income of around $74 million.
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KROLL: $74, OK, and then, I guess, plus the income you made in this quarter,
right?
A. BENNETT: Plus the income and then less the impairment.
KROLL: Great. Thank you.
J. ROWE: Thank you all.
D. OAKES: I just want to remind everybody that the transcript of the prepared
portion of today's call will be posted on the investor information portion of
the Aetna Web site by 3 p.m. today. And please, if you have any follow-up
questions further, feel free to call me or one of my colleagues in the investor
relations office. Thanks very much.
OPERATOR: Ladies and gentlemen, that does conclude the conference call for
today. We thank you for your participation and ask that you please disconnect
your line.
END
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