Centene - Earnings Call - Q1 2025

Executive Summary

• Q1 2025 delivered strong EPS and revenue growth: GAAP EPS $2.63 and adjusted EPS $2.90 (+28% YoY), premium and service revenues up 17% YoY to $42.49B, and operating cash flow of $1.51B.
• EPS materially beat Wall Street consensus ($2.90 vs $2.52*), while premium & service revenue was modestly below consensus ($42.49B vs $43.25B*); beat driven by SG&A leverage, early-year Medicare Part D HBR dynamics under IRA, and robust Marketplace enrollment.
• Guidance raised: premium & service revenues increased by $6B to $164–$166B (from $158–$160B in Feb and $154–$156B in Dec), with total revenue now $178.5–$181.5B; EPS floors reiterated (GAAP >$6.19, adjusted >$7.25).
• Catalysts: strength in Marketplace membership (+29% YoY), Medicare PDP (+22% YoY), and policy visibility around enhanced APTCs and Medicaid rates; management highlighted progress on Medicaid margin recovery and Medicare breakeven trajectory by 2027.

What Went Well and What Went Wrong

What Went Well

• Robust EPS performance: Adjusted EPS of $2.90 (+28% YoY) and GAAP EPS $2.63, with SG&A ratio improving to 7.9% (vs 8.7% adjusted in Q1 2024) due to scale and PDP growth.
• Membership and revenue expansion: Marketplace +29% YoY to 5.63M, PDP +22% YoY to 7.87M; Medicare revenue +48% YoY and Commercial +31% YoY, reflecting strong product positioning and retention.
• Raised revenue guidance by $6B driven by outperforming Marketplace enrollment and stronger Medicare Advantage retention; CEO reiterated adjusted EPS floor >$7.25: “attractive opportunities to grow from the strength of our core businesses”.

What Went Wrong

• Elevated Medicaid HBR (93.6%) and consolidated HBR (87.5%) impacted by $130M of excess flu/ILI costs beyond initial expectations; masks underlying Medicaid MLR improvement.
• PDP specialty drug utilization pressure in non-LIS populations (as max OOP fell to $2,000 under IRA), partially offset by demo risk corridor and SG&A gains; management anticipates incorporating higher specialty trend in 2026 bids.
• Marketplace HBR ticked higher (75.0% vs 73.3% last year) due to 1.9M new members’ early-year utilization before risk adjustment recognition; prudently awaiting first Wakely file (late June/early July).

Transcript

Operator (participant)

Note today's event is being recorded. I would now like to turn the conference over to Jennifer Gilligan of Investor Relations. Please go ahead.

Jennifer Gilligan (Head of Investor Relations)

Thank you, Rocco, and good morning, everyone. Thank you for joining us on our First Quarter 2025 Earnings Results Conference Call. Sarah London, Chief Executive Officer, and Drew Asher, Executive Vice President and Chief Financial Officer of Centene will host this morning's call, which also can be accessed through our website at centene.com. Any remarks that Centene may make about future expectations, plans, and prospects constitute forward-looking statements for the purpose of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in our First Quarter 2025 press release, Centene's most recent Form 10-K filed on February 18, 2025, and other public SEC filings, which are available on the company's website under the Investor section.

Centene anticipates that subsequent events and developments may cause its estimates to change. While the company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. The call will also refer to certain non-GAAP measures. A reconciliation of these measures with the most directly comparable GAAP measures can be found in our first quarter 2025 press release. With that, I would like to turn the call over to our CEO, Sarah London. Sarah?

Sarah London (CEO)

Thanks, Jen, and thanks, everyone, for joining us as we review our first quarter results and updated full year 2025 outlook. This morning, we reported first quarter adjusted diluted EPS of $2.90, consistent with the expectations we shared with investors last month. Our full year 2025 adjusted EPS expectations remain unchanged at greater than $7.25. We have increased clarity on the components of our 7.25 floor and have moved some of the underlying metrics as a result. Drew will cover these and other details of the quarter in a moment. Uncertainty and change are not new to Centene, and we are managing the business well while navigating a dynamic policy landscape. Relative to the active national dialogue around healthcare policy reform, we believe a few things are important to note. First, we do not see broad support for benefit cuts in Medicaid from either the White House or from Congress.

In fact, over the last few months, we have witnessed an increase in bicameral Republican members objecting to major Medicaid reforms. While there is building momentum around work requirements within the expansion population and opportunities to drive better efficiency in the system for beneficiaries and the states, we believe that large-scale benefit cuts and significant policy changes would present challenges for the reconciliation process. Second, there is growing bipartisan recognition in Congress that the expiration of the enhanced premium tax credits must be addressed before they expire at the end of the year. A recent survey conducted by leading Republican pollsters found that 78% of swing voters support extending healthcare premium tax credits for working families.

The criticality of these tax credits for Republican voters, small business owners, and our existing rural healthcare infrastructure, as well as the potential of the individual marketplace to serve as a platform for ICHRA growth, has taken root for many Republican congressional leaders. Congress is scheduled to return from recess next week, and we expect activity focused on driving the contours of a reconciliation bill as the first order of business. Republican lawmakers are targeting Memorial Day for a reconciliation bill, but much will depend on the consensus-building process. Beyond reconciliation, the next big order of business will be government funding due to expire at the end of Q3. We anticipate this could be another vehicle where healthcare issues are addressed. Amid this backdrop, we continue to execute on our strategic initiatives while advocating for sound healthcare policy.

We have demonstrated the ability to be successful under multiple administrations and expect nothing less as we navigate the next four years. Turning to the core business, Medicaid took important steps forward in the quarter as we continue on our path of margin recovery, including better alignment of rates and member acuity in more geographies. As we noted back in February, approximately 40% of our Medicaid revenue received refreshed rates at the start of the quarter, with an average increase of 4.5%. These rates contributed to underlying improvement in the performance of the book. However, the full impact of this improvement was masked in the quarter by a more active flu season than we anticipated. In Medicaid, flu and ILI drove $130 million of incremental medical expense in the quarter beyond our initial expectations, largely offsetting the underlying MLR improvement we experienced.

On the rate front, our discussions with state partners continue to be constructive and to benefit from increasingly complete data demonstrating the acuity shifts the industry has seen over the last year as a result of the tailing redeterminations process. We continue to believe that Medicaid will ultimately return to pre-pandemic margin levels as we work through the coming rate cycles and engage with our members to deliver high-quality, low-cost outcomes. On the business development front, we delivered several key Medicaid contract wins since the start of the year, underscoring the strength and competitiveness of our unique service model. Centene was selected by the state of Illinois to continue providing Medicare and Medicaid services for dually eligible members through a Fully Integrated D-SNP. The D-SNP program will provide services and support statewide for members who qualify for both Medicare and Medicaid, as well as dually eligible MLTSS members.

In the state of Nevada, our SilverSummit Healthplan has once again been selected by the Nevada Department of Health and Human Services to serve its Medicaid Managed Care program. For the first time, the program will include expansion of Medicaid Managed Care into rural and frontier service areas, allowing us to grow our footprint across the state. These wins are testimony to Centene's expertise in both high and low acuity populations, making us a partner of choice in states across the nation. Our Medicare segment performed in line with expectations during the quarter as we advance our Medicare Advantage business on a path toward break-even in 2027 and manage the evolution of Medicare Part D amid significant program changes due to the Inflation Reduction Act.

As you saw from this morning's press release, we have added $1 billion of annual revenue to our outlook for 2025 as Medicare Advantage membership is shaping up to be a little stronger than we previously anticipated. This better-than-expected membership is being driven by improved retention, and we are pleased to be able to attract and retain lives through our strengthening Medicare value proposition. As we plan for 2026, we were pleased to see the inclusion of more recent claims data in the final 2026 Medicare Advantage rate calculation, resulting in rates that better reflect the medical cost trend we've seen in MA over the last two years. There will still be gaps to close between rate and cost across certain geographies, but this step forward was important as we look to deliver valuable benefits to seniors and return our business to break-even in 2027.

In addition to rate, the critical levers we are pulling to drive to break-even in Medicare Advantage are Stars results, value-based clinical initiatives, and operational efficiency through SG&A reductions. On the Stars front, we continue to see momentum, and while a number of components remain outstanding, we are projecting underlying improvement across chapters. That said, we are conscious of the fact that cut points, or the relationship between absolute scores and corresponding Star ratings, have become more difficult due to recent methodology changes and variability in competitor performance. With that in mind, we took on the challenge to de-risk our Stars outcomes for 2027 and to build a plan that supports our 2027 break-even trajectory across the range of projected outcomes expected this October.

Through the identification of cost-saving opportunities and operational levers, we have increased confidence in our ability to generate break-even results in 2027 with our current Star ratings, or 55% of members in three-and-a-half Star plans, with improvements on those results giving us increased flexibility and potential upside in our break-even path. As always, rates for 2027 will be an important input, and we will continue to advocate for program funding that supports the critical healthcare needs of Medicare Advantage beneficiaries across the country. Finally, our commercial segment, which includes our marketplace business, grew nicely during the first quarter as new enrollment and retention were both stronger than previously anticipated. The impact we experienced relative to the reintroduction of integrity programs like Failure to Reconcile or FTR, was more muted in the period than we originally forecasted, contributing to better-than-expected member retention.

This membership strength is reflected in the full-year revenue increase we issued earlier this morning. Recent CMS guidance suggests that ultimate FTR notifications and actions won't be taken until this summer, suggesting we won't see the full impact of this member shift until Q3. As a reminder, we have these and other seasonal member attritions already baked into our full-year forecast. In other policy news, CMS issued the Marketplace Integrity and Affordability Proposed Rule last month, including standards for the health insurance marketplaces as well as for health insurers, brokers, and agents who connect millions of consumers to affordable individual coverage. We are engaging with CMS on these policy proposals and working to model the potential impact of each component. The only major provision that would impact 2025 would be the discontinuation of the continuous SEP for members below 150% of the FPL.

The rest, depending on what gets finalized, would influence market and membership dynamics beginning in 2026. With respect to enhanced APTCs, we remain optimistic that legislators will act to preserve these tax credits given the value they create in health outcomes and market stability, but we are preparing for a range of potential outcomes as we establish plans for marketplace pricing and product positioning in 2026. While there are a number of factors that could impact the marketplace operating landscape over the next year, as a category leader in this business, we look forward to navigating the near-term dynamics from a position of strength and recalibrating our book with a focus on margin and long-term profitable growth.

Stepping back, as we survey the performance of our diversified portfolio, we are pleased to reiterate our full year 2025 adjusted EPS outlook of greater than $7.25 amid sector volatility that is unmatched in recent history. With three months under our belt, we are prudently guiding with an element of conservatism to acknowledge at this early stage in the year the many moving parts we are managing. We remain excited by our long-term trajectory, including the attractiveness of our end markets, our positioning to capture meaningful market share and the associated earnings power, and the exceptional Centene that is mobilized and executing against these opportunities, committed to delivering value to our shareholders and to transforming the health of the communities we serve, one person at a time. With that, I'll turn it over to Drew to cover the quarter and full year view in more detail.

Drew Asher (EVP and CFO)

Thank you, Sarah. Today, we reported First Quarter 2025 Results, including strong premium and service revenue of $42.5 billion and adjusted diluted earnings per share of $2.90 in the quarter. A good start to 2025. While we manage the company as a diversified portfolio, let's go segment by segment for some insights of how we've been able to manage various tailwinds and headwinds to yield a strong aggregate result so far in 2025. Medicaid membership was stable and right in line with our expectation of 12.9-13 million members. The Medicaid HBR, excluding excess influenza-related costs, was approximately 93%, showing some progress compared to 93.4% in Q4 of 2024. You'll see the print at 93.6%, including about $130 million of Q1 influenza-related costs above our expectations.

At a conference in March, we had also cited $130 million of excess influenza costs through February, and consistent with CDC data, influenza settled down as we got into March. Fundamentally, we continue to make progress matching rates and acuity, the key word being progress, not completion. For instance, our 4-1 rate cycle, representing about 11% of Medicaid revenue, yielded an approximate 5% rate increase, though still inadequate for that 4-1 cohort in areas such as MLTC, home and community-based services, and emerging high-cost drugs. Progress, but more work to do as we get through 2025 and into 2026. On our entire Medicaid book, we are projecting a full-year composite rate increase at 4% plus. Medicare Advantage and PDP both outperformed on membership. We retained more membership than expected during the Medicare Advantage open enrollment period, which bodes well for long-term earnings power.

This is contributing $1 billion to our 2025 premium and service revenue guidance increase. PDP ended the quarter at 7.9 million members, strong growth from 2024. Medicare segment HBR was 86.3% in the quarter, which, as we covered in past discussions, is expected to follow an inverted slope line compared to 2024 due to the Inflation Reduction Act program changes. A lower Medicare segment HBR and higher earnings early in the year, and a higher HBR and lower earnings later in the year. Within the Medicare segment, both Medicare Advantage and PDP businesses were on track in the quarter. You will see an intra-year increase in the Medicare Advantage PDR, Premium Deficiency Reserve, that was planned for and is solely related to the sloping of earnings during 2025. No change in our view of Medicare Advantage earnings for 2025.

Commercial membership was very strong in the quarter, not just during open enrollment for 1-1, but also in February and March. Q1 commercial segment HBR at 75.0% was a little higher than last year's 73.3%, driven by 1.9 million new marketplace members in Q1. These members are utilizing a little more than last year's new members, but because it's so early in the year, we are not yet recognizing a matching offset for risk adjustment. We'll know more when we get the first weekly file in late June, early July. Given top-line performance in Q1, and even as we forecast net membership attrition throughout the rest of the year, we are adding $5 billion of premium revenue to 2025 guidance related to marketplace.

Moving to other consolidated P&L and balance sheet items, our adjusted SG&A expense ratio was 7.9% in the first quarter compared to 8.7% last year, which decreased due to continued leveraging of expenses over higher revenues and good discipline. Cash flow provided by operations was $1.5 billion for Q1, primarily driven by net earnings. Our debt to adjusted EBITDA was 2.8 times at quarter end. Our medical claims liability totaled $19.9 billion for Q1 and represents 49 days in claims payable, a decrease of four days as compared to the fourth and first quarters of 2024, driven by significant revenue growth in the PDP business. The decrease in days was expected given the mixed impact of our PDP business, which will be a $16 billion-plus business in 2025 versus $5.2 billion last year.

As I'm sure you know, pharmacy claims complete much faster than medical claims, causing the mixed-related mathematical reduction to DCP. Looking at the full year, we are pleased to reiterate greater than $7.25 of adjusted diluted EPS. As you've heard, the theme of the quarter was strong premium revenue growth and stronger-than-expected membership. Accordingly, we are increasing premium and service revenue guidance to a midpoint of $165 billion, up from $159 billion. We are also recalibrating the consolidated HBR to reflect this growth and a couple of other items. Fifty basis points is driven by, one, incremental Q1 growth in marketplace, with that growth assumed for now to be at a lower-than-average margin level. Two, a full-year Medicaid HBR in the mid to high 91s, inclusive of flu from Q1. Three, very high utilization of specialty drugs in non-low-income PDP members.

While most of this is covered by the PDP demo risk corridor, some of it makes it to our P&L. When coupled with SG&A outperformance in PDP, we are still on track for a PDP pre-tax margin in the 1%s. We are also lowering the consolidated adjusted SG&A ratio midpoint by 45 basis points, given strong performance in Q1 and based upon our 2025 growth and mix of business. We lowered investment income by $100 million as we reforecasted cash balances and calibrated potential rate cuts. On track for 2025 at this early point in the year, with a very strong top line creating attractive long-term earnings power. Now, a few educational comments on 2026, since much of what we do in 2025 sets us up for success in 2026.

On marketplace, there are two items that, if finalized, would impact the 2026 market size and risk pool that need to be reflected in 2026 pricing. Potential expiration of EAPTCs is one that we've discussed here before. The second item, as Sarah mentioned, is the new marketplace integrity and affordability proposed rule released in March, with provisions that would impact 2026. Looking at actuarial studies, these two items combined may cause high single-digit price increases, and that's before, before any baseline trend adjustments, pricing forward trend for 2026, and potential tariffs. While the proposed rule changes seem likely to get implemented, we are still optimistic about lawmakers seeing the merits of continuing EAPTCs. Over half of our states have agreed to accept two sets of rates, one with enhanced APTCs and one without, in case there's clarity by July.

Rest assured, we are on top of adequately pricing for these matters. PDP, the high specialty drug trend, being partly driven by pharmacy industry behavior, will need to be reflected in 2026 bids along with the assumption that the demo risk corridor will not be repeated at the same protective level. We will also be thinking about potential tariff impacts when making bid decisions. Remember our discussions last year about the PDP direct subsidy substantially rising in 2025 due to forecasted IRA dynamics? That landed right where we thought it would. We expect another year of a large direct subsidy increase, maybe to over $200 compared to this year's $142, because of the intentional and maybe unintentional cost consequences of the IRA.

Again, we are focused on making adequate pricing moves coupled with a higher PMPM yield as we think about being responsible in our 2026 decisions being made in the next month or two. We are very pleased to deliver a strong Q1 and more earnings power for the future. Thank you for your interest in Centene, Rocco. We open the lineup for questions.

Operator (participant)

Yes, sir. As a reminder, if you'd like to ask a question, please press star then one at this time. If your question has already been addressed and you'd like to remove yourself from queue, please press star then two. Our first question today comes from Josh Raskin at Nephron Research. Please go ahead. Hi, thanks. Good morning.

Josh Raskin (Research Analyst)

I was wondering if you could just give some more details about the flu-related costs that you cited, specifically if you're seeing more physician visits, I'm assuming primary care and maybe even a specialty. How confident are you that these are flu-related and not related to some uptick in trend that could lead to downstream utilization? I want to make sure all of that was contained in Medicaid. You're not seeing any of that in the Medicare book, correct?

Sarah London (CEO)

Hey, Josh. Good morning. Thanks for the question. The $130 million that we saw above expectations in Q1 in Medicaid is a result of very closely tracking. We have a clear and consistent definition for flu and what we call ILI or influenza-like illnesses. That is what drove the $130 million. Again, it's a consistent code set that we've used over the last eight years.

We also look at sort of flu-related illnesses. We do not include that in the calculation, but it does support the view that obviously CDC reported this was the most acute flu season in the country seen in the last 15 years. We saw both in sort of core flu utilization and then sort of knock-on effects. That $130 million is isolated to our standard flu definition. We did see some flu in marketplace and in Medicare, but not the same as the $130 million that we saw in Medicaid. We saw that trail consistent with the national trajectory pretty hard down in March. We think that is isolated to a Q1 item.

Josh Raskin (Research Analyst)

Gotcha. If I could just sneak in, I did not hear a commentary around the long-term embedded earnings. I think you have talked about $3 to $4 in the past. I just wanted to make sure that was consistent, especially in light of your comments around MA getting to break even without the Stars improvement.

Drew Asher (EVP and CFO)

Yeah. Clearly there's still opportunity to expand Medicaid margins. That's clear based upon the current HBR and what we're forecasting for this year. Still excited about and even actually probably more optimistic about the ability to get to break even. Depending on the levers we can pull, the Stars results, and then the 2027 Medicare revenue, maybe even beyond that. That still holds. PDP, we're still on that 1%-ish area in pre-tax for this year. Even with a little bit of pressure or a fair amount of pressure in non-low-income specialty costs, we're making that up in SG&A. That still presents an opportunity for margin expansion. On top of that, we've just added $6 billion more in revenue, which is exciting to think about the earnings power of that over the next few years.

Operator (participant)

Thank you. Our next question today comes from A.J. Rice at UBS. Please go ahead.

A.J. Rice (Managing Director)

Hi, everybody, and thanks for the question. Maybe just ask a couple of the Washington-related questions. I know at the Investor Day, you guys had sized your estimate of what the headwind would be if the public exchange subsidies, enhanced subsidies were to go away at about a dollar a share. You've mentioned some new things today, and I really wasn't clear whether the tariff comment was related to public exchanges somehow. Is that dollar still a good number, or how has your thinking evolved on that, if it has at all?

You also mentioned the work rules, which does seem to be something that a lot of these guys are talking about. I wondered just conceptually how to think about that if plans are asked to be the ones that sort of get the attestations about whether people are adhering to the work rules, work rule requirements, etc. How much of a burden would that be, and how impactful would something like that be on the business, do you think?

Sarah London (CEO)

Yeah, thanks, A.J. Great questions. The dollar is still good relative to the view of enhanced APTCs. We're working through the process of sizing the elements that came out in the proposed rule for marketplace and obviously interfacing with CMS and providing feedback.

As we see what gets finalized and for what periods of time, I think we can provide an update on the interplay of those provisions with the enhanced APTCs. Obviously, we'll have hopefully increased visibility on what's going to happen with the enhanced APTCs as we get into Q2 and the Q3 timeframe based on a belief that either through reconciliation or through the government funding vehicles that Congress will act on the extension of those. More to come, but we're obviously watching that closely and sizing both the potential impact and the interplay. Relative to work requirements, these, as you know, are not new. We have work requirements in some of our states today. We've also seen them come and frankly go in our states over the years.

Based on that experience, really a lot depends on what the ultimate framework is and the definition of able-bodied adults, what the carve-outs are. We really would expect a high degree of variability in how they and if they settle out at the state level, which again is not new for us, right? We operate in 31 states for Medicaid, which means the programs are all different. We're very used to sort of tracking these changes on the horizon and then working closely with our state partners to understand how they would implement them. We've seen different levels of dependency or expectation relative to MCO's involvement in that process. We think there's a great opportunity to lean in there and map out state-by-state ways that we can ensure that members continue to have access to critical healthcare resources. Our teams are already at work on that process in anticipation of what may or may not come on the work requirements front.

Operator (participant)

Thank you. Our next question today comes from Justin Lake, Wolfe Research. Please go ahead.

Justin Lake (Analyst of Healthcare Services)

Thanks. Good morning. Just talking on the exchanges, the risk adjustment numbers have been bouncing around for a lot of your peers. I believe Wakely just gave an update there. Curious with Wakely's numbers kind of look versus yours. Were you able to move your risk adjustment around much in the quarter versus year-end for 2024? That number does look kind of different than what it did in the end of 2023 versus 2024. Just curious how you see your risk pool changing. Looks like your payable was down pretty meaningfully.

Drew Asher (EVP and CFO)

Yeah, actually, I know it's early. If you pull out the 10-Q we just filed, there's very good consistency, almost exact consistency when you look at Q4 2024 versus where we ended up at Q1. The Wakely data that we get continual updates on relative to the 2024 year was very consistent with our estimates. Nothing sort of out of line in the quarter relative to our estimates at year-end for where we think we're going to end up for 2024. Pleased with that. The real question is going to be the utilization we're seeing in our new business, our 1.9 million members. Some of that does look consistent with what should show up in 2025 risk adjustment. We think we're being prudent, sort of waiting to see if that's going to be the case when we get our first view of 2025 risk adjustment data, which comes at the end of June, early July for that first Wakely data dump for the industry.

Operator (participant)

Thank you. Our next question comes from Ann Hynes at Mizuho Securities. Please go ahead.

Ann Hynes (Senior Healthcare Services Equity Analyst and Managing Director)

Good morning. Thank you. I know when you gave original guidance for Medicaid rates the second half, you assumed, I believe, around the 2.5% rate increase. Is that still the case? Do you have increased visibility on how those negotiations are going for the second half? That would be my first question. Maybe secondly, with Medicaid, besides the flu, is anything running hotter than you expected versus when you gave original guidance?

Sarah London (CEO)

Thanks, Ann, for the question. Composite rate for the full year, we're now seeing at mid-fours. The rate negotiations relative to upcoming, so think about the 7-1 cohort, which is the next cycle, we will start to get visibility into that as we get later into Q2. More to come on that front. As you heard me say, I think we're seeing good continued momentum in our discussions with state partners and the fact that as we roll forward, we have further completion data behind us in terms of the acuity patterns that started to emerge in Q2 right around this time last year. That helps bolster the conversation in terms of supporting the actuarial calculus and I think helps in conversations with the states. Obviously looking to that 7-1, 9-1, and 10-1 cohort to contribute to the back half of the year. I think you asked about Medicaid utilization beyond flu. We continue to see largely the same themes. Drew, maybe you want to click into a few of those.

Drew Asher (EVP and CFO)

Yeah, Clearly we had the flu of $130 million Q1. That's transitory. Behavioral health continues to be a trend item. We've mentioned that probably for the last six quarters. We've got initiatives to tackle that and working with our state partners, things like applied behavioral analysis. I guess no surprise coming out of the pandemic era. There's pockets of home health. We've mentioned that before. Things like attendance services where we can tighten, do some audits. Probably the area of uptick is high-cost drugs. An example might be a Elevidys, which curiously is a $3.2 million single treatment drug that if you read the JAMA articles, it's questionable in terms of the efficacy. Looking at we're all trying to keep healthcare affordable. That seems quite extreme for the cost of a single treatment for a newly approved drug last year. That is an area of uptick that effectively is on the back of the federal and state governments and us as a payer. That is one thing we're watching. We thought about that as we lifted the Medicaid HBR into the mid to high 91s from our previous guidance.

Operator (participant)

Thank you. Our next question today comes from Stephen Baxter at Wells Fargo. Please go ahead.

Stephen Baxter (Managing Director and Senior Equity Research Analyst)

Hi, thanks. I was just hoping that you could help us understand a little bit better how you're thinking about the progression of Medicaid MLR throughout the balance of the year. I know you mentioned that I think you have 11% of your rates in the second quarter and a decent rate update there. It looks like you have a lot of work to do to get even the exit rate MLR down to the level that you've now guided to for the full year. Just trying to understand the progression and why we should be able to think about getting from 93 on the core in the first quarter to something probably in the 90-91 range by the fourth quarter to kind of make this all fit together. Thank you.

Sarah London (CEO)

Yeah, thanks, Stephen. Obviously, there are two key levers to the progression of the Medicaid MLR. The first is rates. I'll let Drew talk a little bit about the assumptions, both again, sort of composite and then how that plays out in the back half. To my comments earlier, a lot of it has to do with the tenor of the conversations that we're having with the states and the fact that we have sort of empirical evidence of the acuity shifts. We continue to have momentum if you look quarter-over-quarter over quarter in terms of those rates coming in to start to address the acuity dislocation. The other lever is obviously what we can do internally relative to clinical initiatives and thinking about the right network partners and ways to ensure that we are consistently interrogating our operating model to ensure that we're delivering high quality, but we're doing so at low cost.

We have a maximum effort on that that has always been in place, but I think picked up through the course of last year, making sure that we are on top of all of those levers that we can pull internally. The coordination of that is really what drives the ultimate outcome. Drew, do you want to talk more specifically about rates and progression?

Drew Asher (EVP and CFO)

Yeah, sure. I'm sure you know this, but we've sort of managed the company as a diversified portfolio. Our goal is to hit the 88.9%-89.5% consolidated HBR. Yes, we provide details underneath that, and we are driving to a mid to high 91% for full year. You're right, that takes some improvement progression. The first half of this year being better than the second half of last year, and the second half of this year being better than the first half of this year, partly driven by rates. If you do the math, our full year is actually 4% plus. That's our full year goal for rates. You could do the algebra and figure out we're betting on mid-threes. We'd probably be disappointed in the mid-threes in the back half of the year, but that's what we're betting on. There are a number of levers where we're working with our state partners not just for rates, but program changes. Actually, there's one state where it's likely we're going to get pharmacy management back after the state tried an experiment and it didn't work. There are other levers where we're working on behavioral health and home health and things I mentioned for the 4-1 cohort. That together should give good lift in the back half of the year in Medicaid, and you'll be able to see that given the detail that we report.

Operator (participant)

Thank you. Our next question today comes from Dave Windley at Jefferies. Please go ahead.

Dave Windley (Managing Director)

Hi, thanks for taking my questions. I wanted to ask just a clarification to Justin's question. Drew, in your answer, you talked about risk adjustment and where you think it would go. I think I know what you mean, but I just wanted to, I don't want to assume. Do you think it should go risk in the risk pool should go up? Is that what you were implying? Then the second question I had was around your membership growth, which looks very attractive. Could you talk about what percentage of your exchange book is fully subsidized? If that was different during this first quarter SEP lift, if you could comment on that too, please.

Drew Asher (EVP and CFO)

Yeah, on the risk adjustment, yeah, thanks for asking the clarification. I always welcome that. If you look at our Q, we did not really book our net payable or receivable did not change from year-end. In other words, we are not booking a big receivable on 2025 risk adjustment in the first quarter, even though we see diagnosis codes and utilization on that new membership that should yield some risk adjustment offset. We'll get more information on that, and hopefully there's that opportunity, but we're not sort of betting on that with what we booked in Q1, given it's so early in the year. No issues with 2024 risk adjustment coming into this year.

Sarah London (CEO)

Relative to membership, the vast majority of our membership is subsidized, which is consistent, always has been consistent with our focus on really serving the lowest income marketplace members seen as a sister population to Medicaid and sort of the natural hedge and synergistic services that serving those two populations affords us. We did not see any major shift in the percentage of subsidized population coming into this OE and what we saw in Q1 in terms of strong growth.

Operator (participant)

Thank you. Our next question today comes from Sarah James at Cantor Fitzgerald. Please go ahead. .

Sarah James (Managing Director and Equity Analyst of Healthcare Services and HCIT)

Thank you I wanted to clarify when you talked about the new exchange lives coming on at a higher MLR, are you talking about the dynamic of just new members not having trended to normal margins yet, or is there something in the acuity or claims data that makes you think these new lives might be a higher MLR or lower margin outside of the traditional ramp? How are you thinking about effectuation rate and where enrollment could end at the end of the year for exchanges?

Sarah London (CEO)

Yeah, sure. Let me start with effectuation rate in Q1 came in strong, sort of at the higher end of our expected range, but generally in the same neighborhood as we normally see. We actually saw meaningfully higher renewal rates this year, which is awesome. That's a result of focused effort from our Ambetter team.

Really pleased to see those results. We are still projecting the same trajectory of membership. Strong Q1 growth means a slightly higher jump-off point, but still expecting, as Drew talked about, that attrition through the year, which incorporates all the assumptions around FTR and a return to more normal seasonality. It means at the end of the year, we're projecting high fours versus that mid-fours that we were talking about on the Q4 call. Nothing changed there, just a slightly higher jump-off point, and everything is sort of baked into the outlook. As Drew said, we are seeing utilization in that new member cohort. Our renewal members are the experience there is as expected. That utilization is really consistent with care that informs acuity and typically flows through to risk adjustment. Think about PCP and chronic care visits. Given that we won't see the weekly data until late Q2, we're taking a prudent posture on that population. We have accounted for that level of utilization in our full year outlook.

Operator (participant)

Thank you. Our next question today comes from Andrew Mok at Barclays. Please go ahead.

Andrew Mok (Director)

Hi, good morning. Wanted to follow up on the Part D commentary. You called out that you're still targeting Part D pre-tax margins of 1%, but you referenced that you might be in the risk corridor, which suggests a lower margin. Can you help us understand how the risk corridor actually works? Is that applied at the contract level or plan level such that we might see a wide range of underlying performance, some of which will be in the risk corridor, but you still net out to 1% pre-tax margins? Thanks.

Drew Asher (EVP and CFO)

Yeah. Good question, Andrew. Part of it, we're making up an SG&A, but it's a nice protective mechanism that CMS, I think, was smart to put in place given the IRA changes. When you get to 2.5%, and this is important, relative to the bid assumption of pharmacy cost, which is not relative to guidance, but relative to the bid assumption and the mechanics of the bids, then there's a 50/50 split if you're off to the bad more than 2.5%. Yes, we're into that risk corridor because of the very high specialty utilization. Like I said in my script, some of which is driven by pharma behavior, pushing cost to the federal government and into the PDP program from what would have otherwise been pharmacy assistant and patient assistance programs. Nonetheless, we've got cover because of that risk corridor. That's what we're thinking about for 2026.

As a payer, we can't assume that that risk corridor will get reinstated at that same level unless CMS clarifies that in advance. That will be reflected in our bids. Yeah, that all adds up to still being on track for a pre-tax margin, the ones, one because of the SG&A help, but then also the protective mechanism, which was good to have in a year where the maximum out-of-pocket went down to $2,000.

Operator (participant)

Thank you. Our next question today comes from Lance Wilkes at Bernstein. Please go ahead.

Lance Wilkes (Managing Director)

Great, thanks. I want to focus in a little more on the specialty pharmacy trends. Can you talk a little bit about what trend level you're seeing for specialty and how it differentiates between maybe PDP, MAPD, and Medicaid? More just to better understand it over in the Part D area, could you talk about are you seeing new prescriptions being written, or is this just a higher same number of units and unit assumptions, but a higher dollar value of that? Maybe just clarification on that three items for the HBR guide lift, if you could just give us a proportion of each of those too. Thanks a lot.

Sarah London (CEO)

Sure. Thanks, Lance. Let me hit the Medicaid piece, and then I'll turn it over to Drew for PDP. One of the things that's important to note, and Drew touched on this, but just so it's sort of firm in everyone's mind, is that ultimately the Medicaid specialty drug utilization ends up getting baked into the state rates. It is a process for that to happen.

One of the things that we're seeing is that states are still trying to figure out how to put programs in place around some of these specialty drugs that are particularly high cost. That can take some time for them to figure out whether they're going to do that as a carve-out or how they're going to manage through it. One of the things that we can uniquely do, and this actually goes back to Stephen's question about sort of why you can have confidence in the progression of the MLR, is that we are able to bring to our state solutions for how to think about dealing with those high-cost drugs. A big piece in Medicaid is just the timing. Again, that will get baked into the rates through a couple of different potential program changes. Drew, if you want to talk about the PDP specialty drug dynamics.

Drew Asher (EVP and CFO)

Yeah, Lance, it's most prevalent in the non-low-income PDP members. Not as prevalent in low-income because they've always been cost-share protected. It does relate to the change in the maximum out-of-pocket going down to $2,000. We thought about that. In fact, we thought about pharma behavior. We thought about member behavior as we priced our PDP business. We didn't expect things like patient assistant programs, barriers to be put up for patients to push them over to the PDP program as severe as what's happening. It's a pretty high trend in areas. I'll give you some categories: asthma, eczema, inflammatories, where we see same members all of a sudden having, for instance, a Dupixent script on one-one and figuring out that that member used to be in a patient assistant program.

The good news is we can absorb that. We can think about that in our 2026 bids. The backstop of the federal government, which effectively is shifting pharma costs over to the federal government because of the risk corridor, that's in place this year. We're on track, and we expect to be on track in PDP. Just sharing some observations that need to make it into the 2026 bids and why we think that direct subsidy is going to be lifted again, which increased the cost of the program. We're good at predicting that stuff and getting that into the bids, and we'll do that for 2026.

Operator (participant)

Thank you. Our next question today comes from John Stansel with JPMorgan. Please go ahead.

John Stansel (Healthcare Services Equity Research)

Great. Thanks for taking the question. To kind of follow up on the Part D side, growth has been very strong this year. Have the new members behaved kind of consistent with your overall pool? Following up on the 2026 theme here, it sounds like based on kind of the wording in the final rate notice and what you're alluding to here that you think that the demo risk corridors might be dialed back in 2026. Do you think that's an industry consensus that everyone expects and will design their bids in that way? Or is there a concern that that might not necessarily be the way that people approach the 2026 bid cycle given all the moving parts?

Drew Asher (EVP and CFO)

In PDP, I think it would be foolish not to assume that because obviously there would be a lot more pressure in that specialty trend if that demo had not been in place. We can tell you what we're going to do, and buyer beware for the rest of the industry. The industry has usually been pretty good about thinking through the elements of what impacts PDP. Look, that's a great business for us, $16 billion plus of revenue. We've been able to manage that well through the years and through the changes, including the IRA. The point is just to showcase what's going on underneath the covers, even though we still believe we're going to hit that 1% plus margin this year and we'll be pricing prudently for next year as well.

Operator (participant)

Thank you. Our next question today comes from Joanna Gajuk with Bank of America. Please go ahead.

Joaquin Arriagada (Equity Research Analyst)

Hey, this is Joaquin Arriagada on for Joanna. Could you talk about any changes to your trend outlook within MA? There have been discussions around Group MA, so have you been seeing anything unusual in your group business in terms of utilization?

Sarah London (CEO)

Yeah, we were, as Drew said, pleased with the membership outperformance. The overall segment is on track, and MA were right in line with expectations. I do not know if there is anything, Drew, you want to add underneath that?

Drew Asher (EVP and CFO)

No, really pleased with the performance of Medicare stability. I mean, obviously, we saw the uptick in outpatient in Q2 of 2023, and we have been planning accordingly for, let's say, outsized trend in that area for the last couple of years. Really consistent, good performance as we progress our way to break even in Medicare Advantage.

Operator (participant)

Thank you. Our next question today comes from George Hill at Deutsche Bank. Please go ahead.

George Hill (Managing Director and Senior Equity Research Analyst)

Yeah, good morning, guys. Thanks for taking the question. Drew, I want another clarifying question. I think I know what you mean, but I want to double-check. You said that you guys were seeing pharmacy pricing pressure as it related to PDP looking at the 2026. I want to make sure that you meant pharma pricing pressure versus pharmacy pricing pressure. I guess, should we think of the PDP target margins looking out to the 2026 bid process as flat? Maybe could you talk about what initiatives you guys feel like you can take outside of the bid process to expand margins in that space?

Drew Asher (EVP and CFO)

Certainly, one of the elements of earnings power that we laid out at Investor Day is to take that PDP margin from the 1% zone to 3% plus. We'll seek to do that over the next few years. Too early to specify exactly what we think for 2026. You're right. We're actually seeing pressure in, once again, non-low-income members' utilization of specialty drugs that are now showing up in PDP, some of which were previously in pharmacy assistant programs. So not pharmacy cost pressures, utilization of specialty drugs, and largely in the asthma, eczema, and inflammatory areas.

Operator (participant)

Thank you. Our next question today comes from Ryan Langston at TD Cowen. Please go ahead.

Ryan Langston (Director and Senior Analyst of Healthcare Research)

Hi, thanks. Maybe just a bigger picture question. I know you mentioned you're seeing some progress on the Medicaid rate side, but how do we think about states' ability to actually fund the necessary improvements that the industry seems like it needs, just given where state budgets are and obviously with the backdrop of these potential funding cuts? I guess, what are the conversations like with your states, and where are they at on being able to fund those improvements? Thanks.

Sarah London (CEO)

Yeah, thanks for the question. I think one of the things you're raising a good point. I think it's important to keep in mind that through the redeterminations process, the states shed a significant number of members, which means they were coming into re-rating with overall budget savings. I think that that has helped the conversations in these early cycles. The other piece of it is obviously that the states legally need to have actuarially sound rates. While there are always budget constraints that states think about, ultimately sort of the math drives the day. The other thing I would say is that historically, when we've seen state budget pressure, it's actually been a tailwind relative to states starting to think about moving additional populations that may not be in a managed care model into managed care because of the predictability of the budget and the savings opportunities that are there.

We hear that time and time again. If you think about the states that have recently moved to managed care, they can actually quantify significant savings that they have seen. That then sort of catalyzes the conversation about some of those more complex specialty populations, which is obviously the group that we have circled relative to driving long-term growth for us as well as margin expansion in Medicaid. We are very experienced at navigating these conversations. I think we have the benefit now of years of data relative to moving through the redeterminations process, a full year of data relative to the acuity shifts. I think we can help states think about where to find savings as they feel budget pressure.

Operator (participant)

Thank you. Our next question comes from Michael Ha with Baird. Please go ahead.

Michael Ha (Senior Research Analyst)

Hi, thank you. Just regarding the exchanges. Firstly, I'm having a little bit of trouble bridging to your expected $5 billion of additional revenue. If I take your roughly 500,000 more lives, $550 revenue PMPM, I'm still getting to only about $3 billion to $4 billion. I know you're still assuming the same in your attrition cadence. I was wondering if you could help me bridge that gap in case I'm missing something. I understand you're assuming incremental exchange growth in 1Q the lower margins. It sounds like it could be conservatism, but wondering what exact margin level you're assuming on those lives.

Lastly, very quickly, when you hear the most bearish concerns about the magnitude of potentially millions of fraudulent lives in the exchanges and the risk that might pose to you next year, I'm just curious to hear your general thoughts, overall level of confidence that this most bear case scenario that's swirling around won't actually happen. Thank you.

Sarah London (CEO)

Yeah. Thanks for the question. Let me start with the last piece of that, and we can sort of work our way backwards. There's obviously been a lot of concern about the idea that there is sort of rampant broker fraud or ghost members in the population. I think it's important to note that the movement to drive additional program integrity, which was understandably loosened during the pandemic, started more than a year ago.

A lot of the program integrity measures that are being put in place are things that we've operated with in the past, which means we have baseline and benchmark data around what some of these rates should be. We were a pioneer in terms of implementing the agent of record lock back in January of last year. We introduced that. We were the first to put it in place. We're seeing the benefit of that. We track very closely the levels of complaints that come in from members or where there are broker issues throughout the year and can understand whether we're seeing upticks in that and anything different than what we would expect. I think we have encountered for things like the failure to reconcile in our full year outlook. Again, the timing of that has shifted.

The team is pretty experienced at understanding the dynamics in the membership. Obviously, the new utilizers that we have where we're seeing utilization is frankly a good sign because it's hard for ghosts to utilize the system. We feel like we have all the data we need to account for how this will play out both through the remainder of this year and in 2026. I think you asked about sort of the level of margin for the new member cohort. Overall, we still expect to be in the 5-7.5% margin range for marketplace. As I said, we've accounted for a continuation of the level of utilization we're seeing in that new member base. In the full year outlook, our renewal members are as expected.

Drew Asher (EVP and CFO)

On your first question, the 10, so we put up $10.1 billion of commercial premium in Q1. If you do the math on our guidance, it's $39 billion for the full year. We are accounting for attrition throughout the rest of the year to end up in the high fours. That sort of hangs together.

Operator (participant)

Thank you. Ladies and gentlemen, this concludes our question and answer session. I'd like to turn the conference back over to Sarah London for closing remarks.

Sarah London (CEO)

Thanks, Rocco. Thanks, everyone, for your time this morning and for your interest. We look forward to continued updates as we move forward and as we manage the business from a position of strength.

Operator (participant)

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may disconnect your lines and have a wonderful day.