UnitedHealth Group - Earnings Call - Q1 2012

Transcript

Speaker 4

Good morning. I will be your conference facilitator today. Welcome to the UnitedHealth Group's first quarter 2012 earnings conference call. A question and answer session will follow UnitedHealth Group's prepared remarks. The queue will not open until the conclusion of the prepared remarks. As a reminder, this call is being recorded. Here is some important introductory information. This call contains forward-looking statements under U.S. Federal Securities Laws. These statements are subject to risks and uncertainties that could cause factual results to differ materially from historical experience or present expectations. A description of some of the risks and uncertainties can be found in the reports that we file with the Securities and Exchange Commission, including the cautionary statements included in our current and periodic filings. This call will also reference non-GAAP amounts.

A reconciliation of the non-GAAP to GAAP amounts is available on the financial reports and SEC filing section of the company's investors page at www.unitedhealthgroup.com. Information presented on this call is contained in the earnings release we issued this morning and in our Form 8-K dated April 19, 2012, which may be accessed from the investors page of the company's website. I would now like to turn the conference over to the President and Chief Executive Officer of UnitedHealth Group, Stephen Hemsley.

Speaker 1

Good morning and thank you for joining us. This morning we will discuss our first quarter results and our updated outlook for 2012. As we said at the start of the year, we are committed to further improving our overall performance in 2012 with continued focus on fundamental execution and practical innovations that serve to modernize the healthcare sector from health benefits to health services. As we've told you consistently, we greatly respect the headwinds facing us this year. Yet longer-term, fundamental market needs for improved healthcare access, affordability, quality, and simplicity continue to grow, regardless of legal or legislative processes. These enduring needs define the dramatic market opportunities that stand before us as we continue to evolve and grow. Steady growth across our enterprise is evident today.

It ranges from the honor of serving Tricare beneficiaries to services and technology supporting integrated care and forward-looking accountable care models, from significant new pharmacy management engagements to states accelerating their pursuits of managed Medicaid solutions, to employee benefits for state governments and large commercial employers, from expanding Medicare market dynamics to statewide health information exchanges. This breadth of growth reflects the diversity of the UnitedHealthcare and Optum businesses, their complementary alignment, and the value of the core competencies of care management, information, and technology they both leverage. In the first quarter, UnitedHealth Group earned $1.31 per share on revenues of $27.3 billion, an increase in revenue of 7% year over year. The consolidated medical care ratio decreased 40 basis points year over year due to higher medical and rebate reserve developments and continued focus on delivering affordable, high-quality healthcare.

As expected, our operating cost ratio increased 80 basis points, driven by the continued strong growth in services at both UnitedHealthcare and Optum, combined with the investments we are making to advance our Optum businesses and particularly our pharmacy services. Adjusted cash flows of $1.1 billion were in line with our expectations. We ended the quarter with a debt-to-total capital ratio of 31% and $1.1 billion in available cash. First quarter annualized return on equity was once again strong at 19.4%. Let's review our business results, starting with UnitedHealthcare, which is accelerating its distinctive and broad-based growth pace. After adding 2.6 million consumers with medical benefits over the past two calendar years, UnitedHealthcare grew by another 1 million people in the past 90 days.

That number is now expected to grow by another 700,000 to 900,000 through the balance of 2012, and we have successfully secured the Tricare WICS contract effective mid-2013. UnitedHealthcare is serving sophisticated employers by combining advanced technology with personalized approaches that really reach consumers and help them take more control of their health. We are advancing newer, more consumer-centric products for smaller businesses that value affordability and cost control. For consumers, UnitedHealthcare offers affordability, responsive service, and an enhanced care experience through our innovative mobile technology offerings. We offer government sponsors a reliable partner who provides cost control for their budgets and high-quality branded offerings to serve their constituents. Execution of these value propositions at the local market level, one consumer at a time, drives consistent, sustained growth. Let's review some of the details. In the first quarter, UnitedHealthcare grew fee-based benefits to serve 765,000 more consumers.

We added 65,000 people in Medicaid, more than one quarter million in Medicare Advantage, and 105,000 in supplemental Medicare benefits. In the process, we strengthened our business nationally with distinctive chronic care capabilities through the acquisition of XL Health. Our Medicare Advantage business now serves 2.5 million American seniors and beneficiaries. As expected, risk-based commercial enrollment decreased 190,000 people in the first quarter, with about half of the decrease due to conversions to fee-based products by large public sector clients that we retain. Because of additional in-year engagements, we are now increasing our membership growth projection for UnitedHealthcare by more than three quarter million to three quarter of a million people, to a range of 1.7 million to 1.9 million new consumers for 2012.

This includes growth of 1.1 million to 1.2 million people in fee-based commercial benefits due to the combination of strong retention and new business awards for both new and existing customers in the national account market. We have also received recent awards for mid-year 2012 implementations of state employer programs in Texas and Nebraska. Full-year risk-based commercial membership is tracking with our previous outlook in the down range of 100,000 to 200,000 for 2012. Including XL Health, we foresee an increase of roughly 350,000 people in Medicare Advantage for 2012. Our two pending South Florida acquisitions would increase this further. Both are locally prominent businesses with well-earned reputations for good management and fundamental local execution, and this is an important region for expansion as South Florida continues to grow its senior population. These acquisitions strengthen our market presence there.

We project our Medicare supplement business will exceed the upper end of our prior outlook for the year. As you know, in standalone Part D, the market bid well below UnitedHealthcare in many regions, causing a decline of 615,000 people in the first quarter, more than we had originally projected, with most of it in the subsidized low-income market segment. Medicaid business growth remains fully on track for the year. We gained the largest share of membership in the first phase of Louisiana's new program this past quarter. We hope to continue to serve well as subsequent phases are introduced. We recently were privileged to receive a new award in Ohio. We are increasing our overall outlook for 2012 medical benefits growth by more than three quarters of a million people across the full spectrum of our product offerings.

UnitedHealthcare's first quarter margin of 8.1% was stronger than planned as results benefited from favorable items that are not considered recurring in nature. They include $130 million in favorable true-ups to our 2011 commercial rebate reserves as we updated our estimates and complied with final federal and state regulatory guidance received during the quarter, as well as including favorable medical reserve development across all UnitedHealthcare business units. Our net commercial premium yields are coming in consistent with our November outlook. Our commercial care ratio is now expected to be at the lower end of our original outlook and is affected by the first quarter's favorable items. We now expect a ratio of 82% plus or minus 50 basis points for the full year.

Based on first quarter data, there is no cause to change our forecast for commercial medical cost trends this year of about 6% plus or minus 50 basis points. Unit costs remain the primary driver of medical costs. Utilization trends remain moderate, with outpatient usage continuing to be the strongest utilization category and inpatient activity remaining restrained. We continue to develop innovative programs to advance the quality and affordability of our products and improve our underlying cost structure. UnitedHealthcare's operations performed well in the first quarter. The strong growth in customers and consumers across businesses was handled smoothly with positive responsiveness and strong customer service. Operating costs were well controlled. Overall, we're pleased with UnitedHealthcare's start for 2012. Optum, our health services business platform, is unique in the marketplace, offering a depth and breadth of capabilities which help modernize the healthcare system.

Our enabling tools and services support healthcare providers, payers, employers, governments, and consumers. We align these capabilities along eight distinct markets, which we size at $500 billion in the aggregate, and our current share at only 6%. All of this we detailed for you at our November Investor Conference. We see accelerating opportunity over the next several years as the market evolves from narrow, highly fragmented single product purchase decisions to customers seeking larger, more integrated and comprehensive solutions. In such an environment, we believe Optum's capabilities will be increasingly differentiated. Optum revenues of $7.3 billion in the quarter increased 8% year over year. Our integrated care delivery business was a significant contributor as it continues to develop and as we expand our footprint in this marketplace. This gain was partially offset by the sale of our clinical trials business late in the second quarter of last year.

In pharmacy management, we expanded the number of people served and saw growth in specialty pharma and mail services. These offset the higher-than-expected decline in Part D volumes and revenues. Compliance services for hospitals and payment integrity services for payers were strong in the quarter. Technology offerings and related service revenues benefited from Optum's rising market profile and reputation. Across our provider-facing markets, our ability to deliver comprehensive solutions differentiates us. One much-discussed example is the growing development of accountable care organizations, an opportunity we define more broadly than regulatory definition alone. As core fiscal and demographic pressures accelerate, the need for providers to connect and integrate, share data, deploy predictive technology, and assume risk will also accelerate. This is an intersection of capabilities where Optum is exceptionally well positioned.

In general, strong sales to healthcare providers and plan sponsors lifted sales bookings for technology and related service offerings 18% year over year. The Optum Insight contract backlog increased 25% to more than $4 billion, both as adjusted. We continue to project overall Optum revenues in the area of $30 billion for the year. First quarter Optum earnings of $252 million were in line with our expectations. The 30 basis point margin decline and decrease of $27 million from the fourth quarter and $70 million year over year was primarily due to planned investments across our business infrastructure, pharmacy services being one of these, and the decline in Part D volumes, partially offset by incremental earnings contribution from newer businesses such as integrated care delivery. Across the entire Optum platform, we are adding significant capabilities as we prepare to take this enterprise to a new level of performance.

We anticipated these factors would impact our year-over-year comparisons for the first half. As we shared with you at our Investor Conference, we're committed to more than doubling Optum's 2011 operating earnings by 2015. This requires a focused, clear, and simple plan. Let us give you a few of its key elements. Optum expects to drive roughly one-half of its earnings growth through 2015 by expanding revenues from key product groups across its eight core markets. Those eight markets serve as a foundation. They are less mature and less regulated than our health benefit businesses and fully lend themselves to the application of our core capabilities in care management and delivery, data analytics, and technology.

Examples of opportunities for Optum's growth include integrated care delivery, coordination of services for the frail elderly, and serious chronic care needs under expanded state and federal programs, expansion in compliance services in a dynamic growing regulatory environment, pharmacy management awards from external clients, and broader development of outsourced technology and services for benefit plans and care providers. The second major component driving us towards 2015 targets is the repatriation of all UnitedHealth Group pharmacy management services by the end of 2013. Finally, there will be a sizable contribution from the tighter integration of businesses, products, and processes across Optum and stronger overall operating cost management. These opportunities lie in tightening alignment and performance around our eight markets and related product sets with a more mature approach to larger and longer-term customer relationships.

We will meaningfully reduce costs across all of Optum by leveraging Optum's enterprise resources and new leadership team. We'll focus spending more directly on improvements in service and further innovation. This requires the right personnel and the right roles, so we continue to move our best leaders to areas that play to their strongest skill set and bring in new talented executives where they can add value. We believe this plan will release meaningful growth in earnings in Optum by focusing resources on markets where we see a high probability of success, repatriating our pharmacy business, maturing and better integrating our products and businesses, and simplifying our administrative structure. Optum is solidly on track with the plans we discussed last fall to deliver operating earnings in a range of $1.3 billion to $1.4 billion for 2012.

This is a moderate advance from 2011 while still shouldering significant incremental development expenses of well over $150 million in 2012. We are committed to distinctive earnings performance and capital returns. We previously characterized 2012 as a build-out year, and we expect steady progress over the course of the year. We are confident in our commitment to achieve a doubling of the return on invested capital from the Optum platform by 2015 and indeed see the long-term opportunities for this business as significant and our market position as strong. To sum up, against a challenging environment, UnitedHealth Group had a strong first quarter characterized by growth across the enterprise, continued cost control, positive earnings, and effective financing and capital use.

Based on these early results, we now project revenues of $109 billion to $110 billion and net earnings per share to be in the range of $4.80 to $4.95 in 2012. This is a $0.17 plus increase at the midpoint from our prior outlook. Cash flows from operations will advance as well to a new range of $6.2 billion to $6.5 billion. These projections are measured and prudent, an appropriate first quarter posture. They recognize growth momentum while weighing significant pressure points on some of our businesses, including that revised reserved estimates benefited UnitedHealthcare's first quarter medical care ratio and operating earnings. Medicare Part D memberships and volumes are behind planned at this point, impacting both UnitedHealthcare and Optum. The opportunity to provide services in 2013 to military families through Tricare will require meaningful ramp-up expenses and capital.

In-year growth in fee-based benefits and services is putting upward pressure on the operating cost ratio. Premium yields on risk-based products are constrained by government budgets and a tight but rational competitive environment. We continue to expect a gradual rise in medical system utilization over the balance of the year. Sequential second quarter earnings per share could run behind what we reported for first quarter 2012, more in line with the second quarter of last year. Continued investments in building our Optum businesses will keep its second quarter margins in check, and UnitedHealthcare should perform at a more natural earnings run rate than it did this quarter. As always, we are committed to delivering our best performance. We like our market position and growth prospects.

We have the opportunity to grow share at UnitedHealthcare, and we have the opportunity to advance Optum to a new performance level by better serving the broad needs of the participants in healthcare. Central to both are our core competencies, our commitments to quality, service, and innovation, and a collaborative, accountable, high-performance culture that pulls it all together. I will now turn this call back to our moderator for questions. I apologize that we never seem to get all of you in despite holding to one question per person. Again, thank you for joining us today.

Speaker 4

At this time, we will open the queue to begin the question and answer period. In order to ask a question, please press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. We request that you do not utilize a speakerphone or headset when asking a question. We ask those with questions to limit to one question per person so we can get to as many participants as possible. We'll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Peter Costa with Wells Fargo.

Speaker 2

Good morning, everyone. Can you guys go over a little bit more about trends in utilization in the quarter? I know you said it stayed, you had no reason to come off your 6% guidance, but can you talk about specifics around some of the subsegments of utilization, you know, inpatient, doctors, and then also just if there were any regional differences or by product?

Speaker 1

Dan?

Speaker 3

Good morning, Peter. This is Dan Schumacher. I would be remiss if I didn't start the conversation with a reminder that our trend, the vast majority of our trend, is driven by unit cost increases year in and year out on our commercial business. With that said, I'll move to utilization. From the utilization perspective, we have incorporated in our outlook historically, as well as going forward, a progressive increase in utilization over the balance of the year. We had incorporated a portion of that in the first quarter. As we look at our first quarter results, they're tracking right in line with our expectations, which is to say that we saw a modest increase in utilization in the first quarter. As you look across both the platform as well as by categories, we saw that increase pretty consistently across Medicare, Medicaid, and commercial.

As you look at the categories, as Steve mentioned, outpatient is the place where we see the most increase. On the inpatient side, we actually continue to see that very restrained. Our hospital bed days are actually flat to down in each of our businesses across the platform.

Speaker 2

All of which is pretty consistent with what we've been seeing.

Speaker 3

Absolutely. That is why our view on our trend for the full year remains unchanged, so we're still at 6% plus or minus 50 basis points.

Speaker 2

If I were to subtract out all of your favorable TPD in the quarter, I get a higher loss ratio than you suggested in your guidance. Does that say that maybe you put back up a lot of that TPD in the quarter?

Speaker 3

I would read into that. Certainly, when we get to the end of each month and quarter, we are picking to our best estimates of ultimate reserve outcomes and ultimate medical expense. We have no expectation of development forward. Certainly, the development we recorded in the first quarter influences our 2011 trend, which is a little bit better than what we were thinking when we closed out the year.

Speaker 1

Next question, please.

Speaker 4

Our next question comes from the line of Jessica Tassan with Bernstein.

Speaker 0

Thanks. Good morning. To follow up on the favorable reserve question, can you break out how much of that came from each of your subsegments? When you report the $530 million, does that include the loss ratio rebate impact in commercial for the commercial portion of it?

Speaker 3

We don't break that. Anna, this is Dan Schumacher again. First, I think one important reminder is that when we're talking about development, that is measuring a change in our medical reserves, whereas our rebates are incorporated in premium. Development in and of itself is not influenced by rebates. Certainly, our rebates are influenced by our development. In terms of where we got development this quarter and where we saw it, we saw it broadly across all three of our business platforms, including commercial, Medicaid, and Medicare.

Speaker 0

OK. I'm understanding $530 million, the rebates were accrued on the premium line item. The $130 million that you came in sounds like more favorably. Is that because you overestimated trend for last year and so you overaccrued? Can you just give us some color on that?

Speaker 3

Sure. On the true-up of our rebate accrual for 2011 in the first quarter, there are a host of factors that obviously influence that. We're measuring it across 350 intersections, so there are changes in estimate. Also, importantly, there were changes to state and federal guidelines that came down in the first quarter that influenced the rebate result for 2011.

Speaker 0

What specifically, if I might just finish up there, were the guideline changes?

Speaker 3

Sure. On the federal side, it was with regard to how capitations would be treated. On the state side, it was more around how the definition of small group would be, whether it went from 1 to 50 or 1 to 100.

Speaker 0

Got it. Thank you.

Speaker 1

If we could move to the next single question at a time sequence. The next, please.

Speaker 4

Our next question comes from the line of Kevin Fischbach with Bank of America.

Speaker 2

OK, great. Thanks. I guess maybe just following up then on the rebate comment. Just want to understand that a little bit better. When you guys, obviously, when you accrue on the cost side, you have a margin for favorable development. Do you have, or sorry, for adverse development? Do you do a similar thing on the rebate side? Do you build in like a margin for favorable development that we might expect in Q1 to have generally a positive true-up there? Or is that more a specific line? I just want to understand how unusual this $130 is.

Speaker 3

Kevin, this is Dan again. That is the adverse margin deviation you're talking about. That's unique to medical. That's not something that relates to the rebate. I would tell you that this is a unique item for this year.

Speaker 2

OK.

Speaker 3

I would say it is the rebates and the reserves are basically estimates. They're done based upon the performance of the book. As a result, those estimates change like any accrual from month to month and quarter to quarter. It is just a normal factor. It does not have a structural element, though, as you suggested, as the adverse deviation would be.

Speaker 2

OK, and one quick one. Is the cash flow guidance simply just the lower rebate payout in 2012? Is that why it's up?

Speaker 3

No, I think there's a variety of factors, Dave. The cash flow guidance is really a result of the improved earnings performance of the business.

Speaker 2

OK, great. Thanks.

Speaker 1

Next question, please.

Speaker 4

Our next question comes from the line of Dave Windley with Jefferies.

Speaker 2

Hi, good morning. Thanks for taking the questions. I wanted to ask you a question about duals. As you evaluate and talk to states and look at the blanket of opportunities, could you give us a sense of how many situations you think it's going to be more of a direct to the incumbents process versus how many situations you think you'll be actually able to show your frail elderly care capability through XL Health and Spiris, et cetera, and actually compete for perhaps even larger share?

Speaker 3

I think that's framed very well. It's a good question. We'll kind of go at it in two directions. We'll start with UnitedHealthcare, but I think Optum will also comment on the duels.

Speaker 0

Sure. Good morning. This is Gail Boudreaux. Let me frame that broadly because I think you asked the right question, which is how well are you positioned to compete in the duals market? From our perspective, we think we're extremely well positioned because we have really strong franchises in both Medicare and Medicaid and serve a number of the chronically ill populations already through our complex care. The XL Health acquisition also offers up some very unique capabilities, the in-house calls, and we're looking to deploy those more broadly. We think that the combination of both our footprint in Medicaid at the state level, working very closely with these populations, as well as the skills that we bring to Medicare, offer us those capabilities. I know that the combination of what we're bringing from our Optum side as well.

I'm going to ask Jack Larsen, who leads our Medicaid business, to give you some comments specifically about some of the state opportunities that we're looking at. We'll ask Optum to share with you some of their capabilities as well.

Speaker 5

Hey, David. Good morning, Jack Larsen.

Speaker 2

Hi.

Speaker 5

I guess I would say at some level, we are working with all of our 25 state partners. As you know, many of those states have posted the outlines of the demonstration plans, seeking stakeholder comments, and then ultimately proposing it to CMS sometime later this spring. I'd say where we are an incumbent Medicaid or incumbent Medicare dual SNP plan sponsor, I think we're in very good shape. I think we bring the best of both of those worlds to bear for the benefit of the dual eligible population. Whether it goes to somebody who is not in the state or to an incumbent, I would say as I look at our opportunities, I really like our position in most of our states. Maybe I'll ask Rick to, or I guess Larry.

Speaker 2

Larry, do you want to take duals from the Optum perspective?

Speaker 7

Sure. I'm going to pass this to Rick Jelinek in a second. I just wanted to make a comment on the market and some of the things that we're seeing. We're being approached as what I'll call an unregulated infrastructure of services capabilities. As we proceed down the road on this, there are a couple of organizations within Optum that Rick will talk about and how they fit. As Gail said, this we see as a very, very strong opportunity. We believe we're pretty well positioned. Rick?

Speaker 6

Thanks, Larry. Thanks for the question. This is Rick Jelinek. As you know, we are a very large service provider to dual populations today on both the Medicare and the Medicaid side on behalf of UnitedHealthcare, as well as on behalf of state customers and other payers. We're a provider of primary care services in physician offices, as well as in long-term care facilities for residents that are permanently placed in an institutional setting and dual eligible. We also provide a series of specialty services through our PBM, our behavioral health businesses, and other network products like our transplant services business, which are also covering a large population of the dual eligible market. Most importantly, we have a full range of care management and disease management programs for all levels of care that are done telephonically in the home setting through our organizations like Spiris and within provider settings.

We can deliver these programs at scale. We have excellent outcomes on the business. We're doing this today with, as I mentioned, health plans and directly with states. We feel we're well positioned. Across all of our UnitedHealth Group businesses, we think we have some very compelling integrated solutions for the dual market.

Speaker 3

Whether it's directly through a program through UnitedHealthcare or through enabling support through Optum, we will serve that population.

Speaker 1

Next question, please.

Speaker 4

Our next question comes from the line of Carl McDonald with CitiGroup.

Speaker 1

Hello?

Speaker 4

Carl, your line is open. If your line is on mute, please unmute your line at this time.

Speaker 1

Why don't we go to the next one? We'll put him back in if we get that fixed.

Speaker 4

Our next question comes from the line of Sheryl Skolnick with CRT Capital Group.

Speaker 0

Good morning. Thank you very much, especially for the explanation of how UnitedHealth Group is intending to grow Optum. Unfortunately, I can't use my one question to ask about Optum. I need to ask a question about the commercial membership situation. I know that you did discuss this several times, that you did expect there to be a contraction in the number of lives that you serve. If you could, I'd like to understand this because given all of the improvements that you appear to be making in affordability, simplicity, and the appeal of the products, the service of the products, it seems a little bit contradictory, as it were, that you would be losing lives on the risk-based products. Can you just walk me through what the situation is there and what the opportunity is to turn that around going forward? Thank you.

Speaker 1

Yeah, why don't we start with Gail? Then Jeff Alter can respond.

Speaker 0

OK. Hi, Cheryl. This is Gail Boudreaux. First, our overall growth was very robust, as you saw, in the commercial market space. We grew 575,000 total lives and had very, very strong fee-based growth. We're really pleased with that. As you look at the risk-based growth, we knew that was going to happen. Let me sort of walk you through the pieces of it. We lost 190,000 lives in the quarter. That was really driven by a couple of large public sector conversion accounts and one large public sector loss. If you look underneath the membership for the quarter in risk-based, we actually had a robust small business group growth and small business, rather, which we think is a strong indicator of the value-based products we put in the marketplace.

We would expect to see improvement over the year, given our guidance of 100,000 to 200,000 loss, which was our expectation. The big driver for the loss was really the conversions in the large public sector accounts that occurred in January. Maybe I'll ask Jeff to comment on just some of the products that we're putting in the marketplace and your view of the uptick in that.

Speaker 5

Hi, Cheryl. It's Jeff Alter. Just to add to Gail's statement, the overall top level is a little bit deceiving as to the fundamental growth that's going on in our marketplace underneath on the fully insured business. We're seeing some very nice uptake on some of our more value-based products, narrower network, some with gatekeepers. We're actually very pleased in the performance of our new products, as well as our overall fully insured block of business.

Speaker 1

Great.

Speaker 3

I would just add, that's a very competitive sector of the marketplace. We are committed to holding on to pricing disciplines, and I think that's clearly a factor in that small group risk-based category.

Speaker 0

I was wondering when you were going to mention that. Thank you. I appreciate it very much.

Speaker 1

Next question, please.

Speaker 4

Our next question comes from the line of Sarah James with Wedbush.

Speaker 0

Thank you. How do you think of the risk reward of bidding in state insurance exchanges as opposed to offering a similarly structured and priced product outside of the exchange? Where are you in the process of establishing those products that would mirror the low-cost exchange option in key markets with respect to development and understanding the margin that that product may have?

Speaker 3

That one could take the balance of the morning. I will start with UnitedHealthcare in terms of kind of the technical side of your question and then perhaps a perspective from Optum as well. I want to start with the exchange.

Speaker 0

Sure. Let me frame your question first broadly because I think you have a couple of different things embedded in your question. The first around the positioning on the public exchanges. We're in the process of actively engaged with the states, and we are taking all the necessary steps inside of our organization to prepare. As we look at that, all the guidance is not out. We haven't made our final determinations. As you think about the preparations that we're making around value-based products, network configurations, clinical engagement, all of those things we are putting in the marketplace now. We have many of our members already. Cost and effectiveness of those products is already in place. To answer your question, we're looking at that market now, and we're preparing for the public exchange. On the private exchange side, we believe that cost and quality will be important.

Consumer engagement will be important and effective clinical models. Those three components. We've got products in our markets today that we are in the process of introducing and have begun that process.

Speaker 7

This is Larry Renfro. From the Optum side, again, it's kind of like the duals. Optum is positioned as what I'll call an unregulated infrastructure with a lot of services and capabilities. I think the way that you could think about it is that we can enable as open architecture, meaning that if you're familiar with and most people would be familiar with 401(k) plans and how 401(k) plans kind of have open architecture with investment products, the way Optum is structured in its technology is to have that type of open environment for different health plans and so forth. We actually do that with a private exchange today. We believe those capabilities are going to play well in the future.

Speaker 3

Like the discussion on duals, direct participation through UnitedHealthcare, and enabling participation through Optum. Next question.

Speaker 4

Our next question comes from the line of Christine Arnold with Cowen.

Speaker 5

Thank you. I want to revisit a question I asked last quarter because I think we crossed wires and asked maybe a little bit more clearly. Could you talk about how you are steering to various providers, how you're lowering overall costs, and where you are, what inning are you in, and what mechanisms are you using to steer utilization to the lower overall cost providers?

Speaker 3

I might frame it from the perspective of how are we incenting the marketplace to use the best resources and those resources to perform at their best levels. I think that's more in the UnitedHealthcare domain. Maybe start with Gail and Jeff.

Speaker 0

Sure. Hi, Christine. Let me try to frame your answer at a couple of different levels and hopefully get to the specifics that you're looking for. As we think about this, the value comes from really a combination of a couple of levers. The first is network configuration, which you just mentioned. Importantly, plan design and how we engage consumers in care and cost decisions are also key. The third is clinical engagement. When we build the products, we're looking for essentially a 10% to 15% price differential. Specific to your question around network configuration, the difficulty in answering it broadly is it does vary market to market and based on how the delivery system is configured and structured. To put an example on that, if we look at our premium designation network, which we've had in place now for over six years, it includes 21 specialties and 145 markets.

Roughly, we look at physicians who practice at a quality and efficiency around evidence-based medicine in the 75th percentile. Roughly 50% of the doctors qualify in those specialties to be in the premium designation network. Of those doctors who qualify, their costs are about 19% less than their peers in those markets. That gives you a perspective of the kind of scale we're talking about. Importantly, within those markets, we're also looking for an improvement in quality. Knee surgery would be a great example. Those premium designated doctors have about a 60% lower complication rate, which drives a lower cost profile. The same thing with spine fusion, roughly a 42% lower complication rate for our premium designated doctors, driving a much lower cost profile. Hopefully, that gives you a sense of the kind of dynamics that we can drive in the marketplace.

Speaker 5

What inning do you think you're in? I know it's a constant process.

Speaker 0

It's an evolving process. I would say we're in the early innings because we've had the premium designation network for roughly six years. That's very mature, but now we're moving up this continuum of more pay for performance. Like I said last, we've quoted a number of roughly 15% of our in-network spend is in these types of arrangements. We're looking to significantly increase that number over the next few years. I would say early innings. There's a lot of improvement in data and technology. Over the next several years, that's going to dramatically improve because products are being built around this and the networks are being configured that way.

Speaker 1

Jeff?

Speaker 5

Hi, Christine. It's Jeff Alter. One of the other areas, we've done a really nice job starting with the premium designation program, creating products around premium designation. As of April 1, we just released our next generation consumer tool called My Healthcare Cost Estimator. We really think this is the next inning, if we want to continue the baseball analogy. This tool allows our members to be better consumers of health care. It gives them a health care shopping experience that allows the member to compare prices and quality for physicians. Since its release, we've gotten very positive feedback from our clients and the people that we serve, mainly because it's a really highly functioning tool that delivers the information in a simple, very personal way. It's an experience that goes beyond just a web tool.

It's integrated with our customer service model, our treatment decision support models, and any questions that the members might have around that. It really is a first-generation release. The game changer, what we think is going to be really revolutionary, will happen sometime in the midsummer, where that data will be actual contracted reimbursement rates. Therefore, that level of pricing accuracy that the member will experience as they shop for health care, as they do other products, is really going to change. We think this could be a good game changer for the second half of the game.

Speaker 0

Christine, I also wanted to clarify one thing in terms of the 15% of our network spend is in pay for performance modality. I just wanted to make sure that was clear because I know I was talking about premium designation as well.

Speaker 3

I'll just summarize by saying basically what you heard is an alignment that's really never really happened before, an alignment between how products are designed, how our consumer engagement tools are designed to work with those products, also designed to work with our clinical programs, and how those clinical programs are designed to work with our high-performance networks. That alignment and the enablement across of it has never really, I don't think, has ever gotten to these levels before. We think this is very early. Next question, please.

Speaker 4

Our next question comes from the line of Scott Fidel with Deutsche Bank.

Speaker 2

Thanks. Good morning. Interested if you can help spike out when you think about the $1.1 to $1.2 million fee-based member ads, how that's breaking out between large public sector client wins versus employers. Maybe talk about some of the key factors that are driving your share gains in the public sector market, particularly against the nonprofit blues.

Speaker 3

I will respond to that. I don't think we'd respond specifically to competitors. We'll just talk about the market in general.

Speaker 5

Hi, Scott. It's Jeff Alter. The majority of our growth in the first quarter happened in employer-based, so traditional commercial. Some of the increase in our outlook for the future is the big wins in Texas and Nebraska. To sum up both sides of that growth, I would say that our value proposition, the network economics that we drive, but more importantly, the recognition that some of the tools that we spoke about, our product design, some of our network configuration designs really are beginning to take hold and to be noticed as different than everyone else. That has powered our momentum to date and continues to change our outlook for the future for growth, particularly in the public sector and some of the larger commercial clients.

Speaker 2

How much runway do you think you still have on the public sector? Do you have an estimate of what your share of those commercial, large public sector clients is right now?

Speaker 3

I don't have specifics. There are still a number of large states that are not our clients that we would hope that our success in our existing state relationships and the two new ones coming up this year will open eyes in other states as well.

Speaker 2

OK, thank you.

Speaker 3

Thank you. Next question.

Speaker 4

Our next question comes from the line of Josh Raskin with Barclays.

Speaker 6

Hi. Thanks. I'll try and ask a quick one. I guess I was just surprised not to hear about the favorable weather, I guess, for you, unfavorable weather, as well as the impact of leap year. Just curious if that had any impact as it relates to medical cost trend and/or your MLRs.

Speaker 3

If you'd like to hear about that, we've got the right guy for you, Dan.

Speaker 6

Good morning, Josh. Last year, obviously, we had a bunch of inclement weather. This year, we've got a little better flu. Those two things are about a wash across the entire platform. Certainly, the extra day in the first quarter of this year is adding to our medical expense in the first quarter of this year as compared to last. I think those are the components. When you talk about your 6% trend, I'm just trying to figure out, is that an apples to apples sort of a PM/PM-based trend? Or is that inclusive of the fact that you had additional services because there was an extra day?

Speaker 3

Our trend is on a full-year basis, obviously. It is at the core of PM/PM comparison, per member per month comparison, so it would incorporate the extra day. As you look at the composition of those days over the balance of the year, there's some ins and outs, and it gets muted over the full year.

Speaker 6

OK. It's only, say, like a 30 basis point impact for the whole year. Apples to apples, your trend would be lower without this leap year. Your MLR would be lower without it, right?

Speaker 3

True.

Speaker 6

OK. Perfect. Thanks.

Speaker 1

Next question, please.

Speaker 4

Our next question comes from the line of Charles Boorady with Credit Suisse.

Speaker 2

Thanks. Good morning. My question is related to medical trend. Maybe to continue from Christine's question, just when you step back and look at the overall secular trend and how much below that secular trend we are right now, I want to understand how much of that is cyclical factors versus structural factors. Steve, you outlined several of the structural changes that you're driving as a company. Maybe you can answer this in two ways. One, how do you measure this pace of structural change? What's on your dashboard for the number of accountable care organizations, % of physicians, and owned group, things that you really monitor to measure the pace of change? Then, how much are you bending the trend as a company versus what is simply a cyclical weakness in medical trend?

Speaker 3

Maybe I'll start this and then hand it off. I would say you ask a difficult question to basically go through the flow of the medical cost trends and be able to parse it as cleanly as your question might suggest. We would love to be able to do that. I think that would be quite a challenge. I would say the things that we do measure are things like how much of our total spend is going towards performance and the continued upward trend of the amount of spend that is based upon performance-based metrics, etc. We measure things like basic UNA measures. We know from our health care affordability programs that we are getting traction on those, and those are fundamental improvements.

I think it is very difficult to measure the impact the consumers are having on this by how they are using products and the influence they're having. It is interesting to observe how consumers behave when you put these tools in their hands and put the right kind of incentives in place. I'd also say it's equally interesting to observe how providers respond when these transparency tools go forward and they begin to measure themselves against others who are providing services in their market, etc. We'd love to be able to take those kinds of inputs and parse them neatly. I'm sure we can build a model, but it would be—and do you have anything to add to that? It is a great question, and it is clearly something we have models on, spend energy on. We do think these elements are all having an impact on it.

Can we offer, particularly in the economic background in which we're operating, that this is a structural rebaselining of medical cost trends? We don't have a basis for that at this point in time. I think you can see from the guidance that we provide that we are watchful and very respectful of medical cost trends and the more moderate utilization realities that we have been seeing. I think that's the best answer we can probably give you at the moment. It's a very good question. Next question, please.

Speaker 4

Our next question comes from the line of Chris Rigg with Susquehanna.

Speaker 2

Good morning. Thanks. Just two maintenance-oriented questions here. Obviously, you bought in $1 billion of stock in the first quarter. Is your guidance for the year still $2.5 to $3 billion? Given the first quarter numbers, is the run rate tracking a little higher in terms of your internal models? Secondarily, can you give us a sense for the Tricare startup headwind? Thanks.

Speaker 3

Good morning, Chris. This is Dave Lichtman. We have not changed our guidance with respect to how much share we purchase. We're still hitting somewhere in the range of $2.5 to $3 billion for the year. We did repurchase about 18.5 million shares for a total cost of about $990 million in the first quarter. We would look to expand the balance of that range over the course of the last three quarters of this year. In terms of Tricare, we are obviously tooling up for that. We've got maybe in the zone of $60 million of costs related to Tricare preparation between ramping up operationally as well as some capital investments that have to be made.

Speaker 6

OK. That $60 million, was any of that spent in the first quarter?

Speaker 3

not in the first quarter, but it's in our outlook.

Speaker 2

OK. Great. Thanks.

Speaker 4

There are no further questions in the queue. I will now turn the call over to Mr. Hemsley for any closing remarks.

Speaker 3

Thank you. In closing, I'd like to quickly summarize what we have said today. Both UnitedHealthcare and Optum are on track and meeting our expectations. We are seeing steady growth across the enterprise in virtually every business segment. The breadth of that growth reflects the diversity of our businesses, how they work together to complement and support each other, and the enduring value of our competencies in technology, information, and care coordination. We're increasing our outlook for 2012 net earnings and membership and cash flows. We remain committed to further improving. Thank you for joining us today. That concludes our call. Thank you.