Oct 23, 2012
Executives
Ed Kroll – SVP-Finance and IR Michael Neidorff – Chairman, President and CEO William Scheffel – EVP and CFO
Analysts
Peter Costa – Wells Fargo Securities Chris Rigg – Susquehanna Ralph Giacobbe – Credit Suisse Joshua Raskin – Barclays Capital Sarah James – Wedbush Justin Lake – JP Morgan Scott Fidel – Deutsche Bank Carl McDonald – Citigroup David Windley – Jefferies & Company Brian Wright – Monnes Crespi & Hardt Scott Green – Bank of America Merrill Lynch Michael Baker – Raymond James
Operator
Good morning and welcome to the Centene Third Quarter 2012 Earnings Conference Call. (Operator Instructions) After today’s presentation there will be an opportunity to ask questions.
(Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Ed Kroll.
Please go ahead.
Ed Kroll
Thank you, operator and good morning, everyone. I’m Ed Kroll, Senior Vice President, Finance and Investor Relations for Centene Corporation.
Michael Neidorff, Chairman and Chief Executive Officer; and Bill Scheffel, Executive Vice President and Chief Financial Officer of Centene Corporation, will host this morning’s call. The call is expected to last approximately 45 minutes and may also be accessed throughout our website at Centene.com.
A replay will be available shortly after this call’s completion also at Centene.com or by dialing 877-344-7529 in the U.S. and Canada or from other countries 412-317-0088.
The playback number for both dial in, both replays is 100 188 06. Any remarks that Centene may make about future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995.
Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those discussed in Centene’s Form 10-Q dated October 23, 2012, today and other public SEC filings. Centene anticipates that subsequent events and developments will 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. With that, I’d like to turn the call over to our Chairman and CEO, Michael Neidorff.
Michael?
Michael Neidorff
Thank you, Ed. Good morning, everyone and thank you for joining Centene’s third quarter earnings call.
This morning I will provide an update on the issues discussed at our June Investor Day and on our second quarter earnings call. I will then briefly discuss our quarterly results and certain macro issues, before turning the call over to Bill for detailed financial results.
Let me begin with Kentucky. Our focus has been and will continue to be one that our members receive the highest quality of care by the most cost-effective means.
Two, that our provider networks receive fair compensation. Three, the plans meet statutory financial requirements.
And finally, our shareholders receive a fair return on the capital employed. We are proud of the positive improvements in health care outcomes we achieved in Kentucky.
These include a 94% decrease in doctor shopping for narcotics; a 53% increase in hemoglobin A1C testing for diabetes; a 30% reduction in pharmacy costs; a 30% decrease in one-day hospital admissions; a 30% increase in well-child visits; a 23% reduction in hospital re-admissions and a 17% decrease in medical surgery costs. In our two decades working with states, this is the first time we have failed to achieve a partnership with a state.
We have experienced significantly higher than expected medical cost in Kentucky. This is due to an unprecedented amount of retroactively assigned members.
Secondly, fraud risk adjustment methodologies, thirdly, policies that are inconsistent with a successful managed Medicaid program, and finally, significant data book issues. We have tried to work with the state on these issues and while Kentucky has offered some changes, they were not enough to cover the higher than expected costs.
I might add that this is not only Centene’s issue. It is our understanding based on statutory filings that the three plans combined lost just under $300 million in the first half of 2012.
We believe this raises serious concerns about the sustainability of the program. Our Kentucky experience has taught us to be cautious with states that are, using managed care for the first time.
Yesterday, we filed a lawsuit in Franklin Circuit Court against the Commonwealth of Kentucky seeking declaratory relief as a result of the Commonwealth’s failure to completely and accurately disclose material information. As expressed in our press release, we will use and exhaust all available administrative and legal remedies to ensure the review of our grievances with the state.
We believe we have a strong case, but will not comment further while these legal matters are pending. Next, let’s discuss Texas.
Our Margin Improvement plan for the Hidalgo expansion area is proceeding as expected, including the increased STAR+PLUS business we took on in the last two months of the quarter. Our HBR in Hidalgo is tracking in the mid 90% range.
Our medical management efforts have gained traction, and we continue to move towards normalizing margins in Hidalgo in 2013. We previously indicated that we expected a 3.7% state-wide rate increase.
Due to member mix, we received 4% effective September 1. Now for an update on Celtic, in June we reported a high level of medical costs in our Celtic individual business.
Our corrective actions to improve performance included a new national network contract, which took effect July 1. We are also putting in place targeted rate increases in the second half of 2012.
Our HBR has improved from over 100% in Q2 to the high 80s in Q3. I would remind you that our Hybrid Celtic business in Massachusetts is performing in line with expectations and is not experiencing the same margin pressures we have reported in the balance of the Celtic book.
Next, third quarter financials, GAAP EPS for the third quarter was $0.07 per diluted share. As you can see on Page 1 of our press release, this is comprised of several components.
Earnings from operations excluding Kentucky are $0.78. Third quarter loss in Kentucky operations is $0.31.
This resulted in adjusted earnings of $0.47, which is in line with the forecast incorporated into our previously communicated annual guidance. The other three items, the $0.69 Kentucky premium deficiency reserves, the $0.21 gain on sales of investments and the state tax relief of $0.08.
Premium and service revenue growth was strong in the third quarter, increasing 75% year-over-year to $2.2 billion. We ended the quarter with 2.5 million members, representing an increase of 55% year-over-year.
This included a Medicaid membership increase of 63% to 1.9 million, ABD membership increase of 126% to 76,900 lives; long-term care membership increased 66% to 7,800 members. Medicare membership increased 29% to 4,000 members.
As you can see, we have continued the growth of our high acuity membership which will be beneficial as more states move long-term care, ABD and dual-eligible recipients in the managed care program. The third quarter HBR came in at 93.3% compared to 85% in the third quarter of 2011.
However, excluding the impact of the Kentucky operations, the HBR is 88.7%. The 370 basis point year-over-year HBR increase is mainly due to new markets, including the Texas expansion, as well as the Commonwealth of Missouri, Washington on July 1 and the phase-in of Louisiana between February and June of 2012.
The Missouri and Washington launches are tracking in line with our expectations. We expect relative stability in the Missouri membership going forward.
Washington should ramp up to over 50,000 lives by the end of 2012. Now a brief discussion of our rate outlook.
Our composite rate increase for the first nine months of 2012 was approximately 2%. While Georgia and Florida are yet to be determined, we believe the full year of 2012 rate increase will come in at 2%.
Now moving to a couple macro issues. Our views of the election outcome and the effect on managed care have not changed.
Regardless of the election results and the fate of the ACA, we believe Centene is well positioned to maintain significant growth. States continue to move recipients out of the fee-for-service and into managed care.
We remain committed to helping states effectively manage their beneficiaries’ health outcomes while reducing expenses. The growth outlook remains more robust than ever with an approximately $45 billion pipeline through the end of 2013.
We expect our new Kansas brand to commence operations January 1, 2013, and New Hampshire to begin late in the first quarter of 2013. We are pleased that Ohio selected Centene to serve Medicaid members in a dual-eligible demonstration project.
This is set to commence in the second half of 2013 and is our first major dual-eligible contract. We continue to believe we are well positioned for future opportunities in this category.
Centene is preparing for the 2014 Medicaid expansion and continues to have conversations with states on future hybrid and exchange opportunities. We look forward to our December 14, 2012, meeting in New York City when we will provide guidance for 2013.
I will now turn the call over to Bill, who will provide further details on the third quarter of 2012 financial results. Bill.
William Scheffel
Thank you, Michael, and good morning. For the third quarter we have provided the detail of the component of our results in our press release, and Michael has covered these at a high level in his comments.
I will address each of the items included in the press release table as I go through our financial results in more detail. For the third quarter of 2012 premium and service revenues were $2.2 billion compared to $1.3 billion in 2011 an increase of 75% year over year.
The $950 million increase reflects the addition of four new states between years along with the Arizona and Texas expansions and the Ohio pharmacy carve-in in the fourth quarter last year. Premium tax was approximately $200 million higher in the third quarter of this year compared to last year, as one of our states paid us approximately $180 million during the quarter to immediately pass through to specified providers.
Our reported health benefits ratio was 93.3% for the third quarter. Our HBR, excluding Kentucky, was 88.7% with Kentucky increasing the consolidated HBR by 460 basis points.
This is due to a third quarter HBR of approximately 115% in Kentucky before the premium deficiency reserve, resulting in the operating loss of $0.31 per share and the recording of a $63 million premium deficiency reserve or $0.69 a share. As discussed in our release and in Michael’s comments, we have taken actions to terminate the Kentucky contract effective in early July 2013.
Our premium deficiency reserve calculations assume that we will operate at approximately the same level between now and July 5, 2013, adjusted for expected changes in the program such as decreases in revenue from risk adjustment. The premium deficiency reserve will be released over the next three quarters including approximately one third in the fourth quarter of 2012.
Looking at Texas, our largest market, we received a 4% overall rate increase effective September 1st. And as we discussed at our Investor Day in June, we have been working to reduce the higher utilization levels seen in the March 1st expansion areas particularly the Hidalgo service area.
For the third quarter our HBR in the Hidalgo service area was in the mid 90s and this includes the cost incurred in mid August and September from the members we added as a result of consumers switching plans due to dissatisfaction with their previous managed care organization. At Celtic, we reported a lower HBR in the third quarter compared to the second quarter as a result of a change to a lower cost provider network and other actions.
We also have implemented or applied for a rate increase in a number of states. In summary we believe the actions we discussed during our Investor Day in June have been substantially implemented, and coupled with the recording of the Kentucky premium deficiency reserve demonstrate that we are addressing the issues which have developed in 2012.
Sequentially, our HBR excluding Kentucky decreased from 91.1% in Q2 to 88.7% in Q3, a decrease of 240 basis points. This reflects overall improvements in most of our operations, particularly in Texas and in Celtic between quarters, offset somewhat by an increase in Georgia’s HBR related to an adjustment to account for changes in the third quarter in the state’s handling of premium adjustments related to retroactive membership deletions.
Our general and administrative expense ratio was 8.2% for the third quarter compared to 11.3% in the third quarter last year and 8.2% in the second quarter of 2012. The decrease in the GNA between years reflects the additional leverage we have gained through our revenue increase along with lower performance-based compensation expense, which lowers our G&A ratio in the third quarter by approximately 50 basis points.
Our investment and other income was $23.2 million in the third quarter this year compared to $2.7 million in last year’s third quarter. The increase is a result of two items, which generated $0.21 of benefit in the third quarter.
First, we recorded a gain of $17.9 million related to a convertible note agreement which we entered into in 2008 with a third party to provide funds for investments in Medicaid and Medicare related businesses. During the third quarter we reached agreement to sell our interest in this investment for a specified amount.
The investment is secured by the underlying operating businesses. The second item relates to a gain of $1.5 million we recorded in the third quarter from the liquidation of approximately $75 million of investments held by our Georgia Health Plan.
As discussed during the second quarter, we had receivables of $221 million at June 30 from the state of Georgia, primarily as a result of the deferral of our capitation payments. During third quarter we received additional capitation payments from the state of Georgia, which reduced our receivables to approximately $100 million at September 30, which reflects one month of capitation payment along with receivables from the State for deliveries and other items.
Interest expense was $4.9 million in the third quarter compared to $4.6 million in the same quarter last year, reflecting higher average borrowings. Our income tax line item reflects a benefit of $9.5 million for the third quarter this year compared to expense of $18.5 million in Q3 of 2011.
We expect to have an effective tax rate of approximately 40% for 2012. We have a pre-tax loss in Q2 and Q3 but an anticipated profit for the full-year.
Additionally, the third quarter benefited by approximately $4.6 million, or $0.08 per share, from a clarification from one of our States which applied to several open tax years related to items included in the State income tax calculation. Our earnings for diluted share was $0.07 for the third quarter compared to $0.55 in the same period last year.
Excluding the Kentucky operations and the investment gains in State tax benefit, our earnings for diluted share from operations was $0.78 for the quarter. At September 30 we had cash, investments and restricted deposits of $1.5 billion, including $36 million held by unregulated entities.
We have estimated our risk based capital percentage, excluding Kentucky, to be in excess of 350% of the authorized control level at September 30. For Kentucky we expect to maintain the minimum required capital level.
Our total debt was $395 million which included $40 million of borrowings under our revolver. Our debt-to-capital ratio was 25% at September 30, excluding our non-recourse mortgage note.
The medical claims liability totaled $919 million at quarter end, an increase of $311 million from December 31. Our days in claims payable, calculated without the expense and liability for the premium deficiency reserve, was 42.8 days compared to 41.4 days at June 30.
Our cash flow from operations was $317 million for the third quarter. The large increase this quarter reflects the decrease in the Georgia receivables and prepayment of approximately $120 million for fourth quarter capitation payments from other States.
For 2012 annual guidance, we have updated our numbers as follows: premium and service revenues $8.1 billion to $8.3 billion; diluted earnings per share on a GAAP basis $0.56 to $0.66; consolidated health benefits ratio 90% to 91%; general and administrative expense ratio 8.5% to 8.8%; and diluted shares outstanding 53.6 million to 53.8 million shares. Our EPS guidance reflects actual results for the first three quarters, including the impairment charge for Celtic of approximately $0.50 that we took in the second quarter.
And the third quarter items discussed this morning, including the $0.69 charge of the premium deficiency reserve and the $0.29 in benefits from the sales and investments from the state tax benefit. Approximately one third of the premium deficiency reserve is expected to reverse in the fourth quarter.
Compared to the guidance we gave during our second quarter call, operations other than Kentucky have performed slightly above expectations. While Kentucky’s results have deteriorated due to additional retroactive assignment of members and an unfavorable risk adjustment change beginning October 1, these items have been considered in calculating our premium deficiency reserve.
Our implied fourth quarter guidance for EPS is $0.70 to $0.80 per diluted share. During the fourth quarter we expect to incur $0.12 to $0.15 for business expansion costs, including startup costs for Kansas, which is slated to begin January 1.
This compares to $0.07 per share for business expansion costs in Q3. In addition, we anticipate incurring $0.04 of exit costs in Q4 for Kentucky related to severance and retention accruals.
Operator, you may now open the line for questions.
Operator
(Operator Instructions) Our first question comes from Peter Costa of Wells Fargo Securities. Please go ahead.
Peter Costa – Wells Fargo Securities
Thanks, guys. Thanks for all the detail on the call.
Can you go through a little bit what’s in that premium deficiency charge, just in terms of the overall size of it? If in the quarter Kentucky cost you $0.31 and going forward you’ve only got $0.69 in the premium deficiency charge, why isn’t it – it’s got to carry you for three quarters.
Why isn’t there a larger charge there at this point? What’s the improvement that you’re expecting to see?
Michael Neidorff
Bill?
Bill Scheffel
Sure. I think the main thing that’s happened is in the third quarter we continued to see a high level of retroactive assignment of members and so we had unfavorable development in the third quarter, which we had to accrue for from almost inception to date.
Even in September we continued to see members assigned to us from November of 2011. So what we did in calculating the premium deficiency reserve, we utilized the HBR calculation that we’ve experienced through the life of the program to date, factoring out development from month or quarter to quarter, then that HBR is actually slightly higher in our PDR calculation for now through the end of June 2013.
We know there’s certain changes in the program that are occurring, and we included those in there, but overall we believe that the $0.69 that we’ve accrued for in our premium deficiency reserve reflects our best estimate of what the costs will be between now and July 5.
Peter Costa – Wells Fargo Securities
Then just a follow-up to that, if I subtract the one-time items in this quarter away from your full year GAAP guidance, your new GAAP guidance is on the lower side of the range that you gave before, which from your conversation sounds like the thing that under performed here is Kentucky, and that Texas and the Celtic business both improved a little bit. So why aren’t we seeing a better improvement than in the fourth quarter, given that you now have the premium deficiency charge than where we would have otherwise been based on your full-year guidance?
Part of it I guess would be explained by the $0.04 of costs from the exit costs from Kentucky. Then can you talk about those exit costs?
Will they carry into next year? Just go through that for me a little bit; help me with the math.
Bill Scheffel
Sure. Let me see if I can cover all of that.
First I’ll start with the exit costs, in our 10-Q that was filed this morning there was a discussion of exit costs that will be incurred between October 1 and all of 2013. These, primarily, relate to severance and retention accruals and lease-termination costs.
Those costs are not included in the premium deficiency reserve calculation; rather they’re expended in the period for which they occur. So severance would generally be expensed in the period that you make those promises, which we would say is the fourth quarter of 2012, and retention bonuses would be expensed over the service period, which would be between now and end of June, July, whenever people stay through.
So that goes – and the least costs can’t be expensed until you – through using the facility that’s available for others. So those costs we’ve estimated I think $5 million to $7 million will be incurred between now and the end of 2013.
About half of that would be included in Q4. With respect to business expansion costs, I think we said $0.12 to $0.15 in Q4, a lot of that for Kansas, and that compares with $0.07 in Q3.
So it’s quite a bit higher in Q4. I think you’re right in the basic premise that Kentucky’s performed worse than we included in our prior assumptions in our guidance numbers.
And we’ve picked that up in our PDR calculation. I think that the $0.70 to $0.80 range for Q4 adjusted for the business expansion costs and the exit costs, really any differential on that is the Kentucky operations.
Peter Costa – Wells Fargo Securities
Okay. Although the business expansion you had given previous guidance of that being $0.20 to $0.22, I think, in the second half of the year.
You’re a little bit below that overall, I guess, because New Hampshire has been pushed out a little bit, but it seems like that would have actually helped you in the fourth quarter.
Bill Scheffel
Yeah, it is. And I’m really thinking of if we had $0.78 in Q3 from operations excluding the onetime and the Kentucky operations compared to the 70 to 80 in Q4.
If you adjust for the differential in business expansion costs and exit costs and you pick up the fact that HBR is generally a little higher in Q4 than it is in Q3. That’s how we come up with our estimate.
Peter Costa – Wells Fargo Securities
Okay. Are you counting anything for legal costs in there in case the state sues you?
Bill Scheffel
We have estimates for legal costs in our numbers, yes.
Peter Costa – Wells Fargo Securities
Okay. Thank you.
Operator
The next question comes from Chris Rigg of Susquehanna. Please go ahead.
Chris Rigg – Susquehanna
Hi. Good morning.
Thanks a lot. Just on the, I guess, are you guys fairly confident that you can indeed contractually get out of Kentucky.
I mean, how can you help us feel a little better that this isn’t going to end up in a long drawn-out legal battle where you can’t get out by mid-2013?
Michael Neidorff
Chris, I’d like to talk more about it, but as I included in my script, we have now filed suit yesterday in the Circuit Court in Franklin County, and on that basis, it’s policy, practice and wise to make no further comments.
Chris Rigg – Susquehanna
Okay. So then, changing gears, when we think about you guys’ incentive compensation, at what margin, prospectively, do you guys start accruing comp for the management team, and how does that equate to a net margin on a GAAP basis for the overall company?
Michael Neidorff
Well, we have several matrix that we look at, and various compensation is evaluated with different programs, long term, short term. Your short term is very much based on the EPS.
The elements of long term are, one of them that we’ll be using more and more in the future is total share holder return compared to a peer group that will be identified in our next proxy statement. So there’s a series of measures we use for different aspects of it.
So in the case of the stock, it’s very much EPS. In the case of short-term, there’s an EPS and margin aspect to it and then long-term is total share holder return, the arrow tip.
Chris Rigg – Susquehanna
Okay. Well, just to – in a more simplified way, so there’s no incentive comp for the management team this year, at least at senior corporate level.
I guess in a normal year, what type – given your run rate now, how much of – how many basis points of margin pressure would the incentive comp have on overall margin?
Bill Scheffel
I think maybe the simplest way to explain that is you’re correct; in 2012 we reduced our performance-based compensation. We still have stock comp expense in there for RSUs and things like that that have been granted and they’re not performance-based.
But for 2013 we would estimate 50 basis points of costs for performance-based compensation and we anticipate including those costs in our guidance that we will provide in December when we’re making that presentation in New York.
Michael Neidorff
Yeah, just a further guidance issue, you can go back to our discussion of compensation in the last proxy, half of the stock awarded is performance-based and that has been forfeited as a result of the outcome of Q2 in the year for the senior officers. As it should be.
I mean, nobody’s – the previous year was a good year. We did well this year, has been a difficult year for various reasons and we don’t change the rules.
They are what they are.
Chris Rigg – Susquehanna
Okay. Great.
Thanks so much.
Operator
The next question comes from Ralph Giacobbe of Credit Suisse. Please, go ahead.
Ralph Giacobbe – Credit Suisse
Thanks. Good morning.
I just – maybe – and I understand you’re going to give 2013 guidance shortly, but I think in previous calls you’d talked about a 280 number being a relevant and decent, jumping-off point or starting point. Does that change at all in terms of thought process with Kentucky out?
And then maybe just talk about the top-line growth opportunities given new contracts in Kansas, the Ohio duals and the annualized new business in 2012.
Michael Neidorff
I think relative to the previous comments made, you all can get to the year end run rates. Bill’s made it pretty clear what the guidance is and that’s what everybody based their last call on, so I’m not going to change that any.
And relative to the growth, that is a subject for December 14th, and I’m not going to speculate ahead of that. That’s the purpose of that particular meeting.
Ralph Giacobbe – Credit Suisse
Okay. Fair enough.
And then you started new business in Washington, Missouri during 3Q. Just help us in terms how MLR’s tracking there and how your experience has been there so far.
Michael Neidorff
Well, we gave the insight into membership, which is consistent. And the MLR we always booked at a higher level in the 90s, as we’ve talked about historically for the first two, three quarters of new business.
So we’ve been consistent with that. So nothing’s changed there.
Bill Scheffel
Yeah. I think it’s performing in line with our expectations for those two markets at this point.
Ralph Giacobbe – Credit Suisse
Okay. Great.
Thank you.
Operator
The next question comes from Josh Raskin of Barclays. Please go ahead.
Joshua Raskin – Barclays
Hi. Thanks.
Michael Neidorff
Good morning.
Joshua Raskin – Barclays
Good morning, Michael. Have you had any discussions with your current state partners around the situation in Kentucky?
And be curious to see any feedback in how you juxtapose that with your 20-year track record versus your nine-month track record in one specific state?
Michael Neidorff
Yeah, I will – I’ll make only one comment. We believe in good, open discussions.
The states we operate in already pardons and works with us. I think you take Texas or any of them; they’re good examples of how when there’re issues we sit down at the table and are able to resolve it, not just for us, but for the industry.
So that’s why they have sustainable programs. And clearly when this was unfolding we had solid communications with our current states and those that we’ll be entering.
And we’ve already won contracts next year. So that has been received.
They understand it and they continue to work effectively with us. They see it as purely a Kentucky issue.
Joshua Raskin – Barclays
Okay. And I guess in terms of looking back at recent RFPs that you guys have been successful in, is there a part of that RFP response that you think you would have to address Kentucky had this happened earlier?
I mean it doesn’t sound like there’s been any legal proceedings against you or anything like that. So I’m not sure where or why you would have to bring it up.
But is there any reason you think this could be included in future bids?
Michael Neidorff
No. I mean I – I mean it’s – we have no trouble discussing it.
We – it’s very clear. Anybody can get a copy of the complaints we’ve filed yesterday and understand what the issues are.
So I think I have no trouble with that. It’s very clear what’s occurred there.
And we had hoped that the state would’ve sat down with us and resolve it as every other state we’ve ever worked with has done. But beyond that I don’t want to get into it, Josh, because of the litigation.
Joshua Raskin – Barclays
That’s fair. And then maybe last question, I don’t know if Bill has this handy, but Mississippi and Louisiana, especially Louisiana a decent size state, any impact from Hurricane Isaac in terms of volumes or impact there in your utilization this winter?
Bill Scheffel
Nothing noticeable.
Joshua Raskin – Barclays
Okay.
Operator
Our next question comes from Sarah James of Wedbush. Please go ahead.
Sarah James – Wedbush
Thank you. I wanted to think a little bit about startup costs here.
As Josh had mentioned, you guys have been very successful. You’ve won about six contracts starting in the second half of this year to 2013 and it’s about $0.40 to $0.47 so far in startup costs that have been mentioned in 2012, though wondering how much of that was in the quarter and what do we know so far from contracts that you’ve already won where the startup costs will continue on into early 2013.
Bill Scheffel
In my comments I said we incurred about $0.07 in Q3 for startup costs and we’d talked I think at the end of the second quarter about $0.20 to $0.22 for the second half and so we’re seeing $0.12 to $0.15 in Q4, and most of that is for Kansas, which will start up January 1. There’s a smaller level for New Hampshire which starts later in 2013 and then 2013 we would expect to continue to have business expansion costs from the Ohio expansion and duals going on in addition to whatever else comes out.
So we will include a good estimate for business expansion costs for 2013 when we prepare our budget.
Michael Neidorff
We give a lot more transparency than of course, Ohio, the duals were already in that state so that’s important, but I think once again, Sarah, the time to talk about that in more detail is on the 14th.
Sarah James – Wedbush
Sure. I appreciate that, I was just trying to get a big, clear picture of where the run rate is right now.
My other question is that it looks like Ohio may have been pushed back again, I think in the release you mentioned second half of 2013. If you have a specific month and can you speak to the reason that (inaudible).
Michael Neidorff
No. There is no specific timing.
Jesse, anything you want to add?
Jesse Hunter
No. I think, Sarah, you’re right.
It has – there’s some movement in the date with respect to that. We mentioned second half for 2012 and obviously there’s – Ohio’s on the front end of these two holds demonstration programs, working with both the State and the CMS level so there’s a lot to be done there and that work’s in process but we can’t be more specific than second half at this point.
Michael Neidorff
I think it’s positive. We like it when the state is in – when states recognize in our rate and go to either the given point in time and they work with us on when the effective date should be, that way they’re – it gets off to a good start.
Sarah James – Wedbush
Okay. Great.
Thank you.
Operator
The next question comes from Justin Lake of JP Morgan. Please go ahead.
Justin Lake – JP Morgan
Thanks. Good morning.
First on the Kentucky exit, your contract includes a fee to exit early, I believe. Can you go over that from a potential cost perspective?
And whether you would expect to have to pay this fee if you’re successful in court?
Michael Neidorff
I think as I said, I really don’t want to talk about it, because of the court case. I’m not going to preclude one way or the other something without going through the steps that are laid out in court.
I’m not going to give somewhere or presume something’s not there. It’s not an appropriate discussion.
I wish I could talk more about it, but that case is filed.
Justin Lake – JP Morgan
Okay. Can you walk us through your capital needs for Kentucky in terms of exiting there?
Do you think that will be net cash positive if you walk away? Then can you just give us an update on where you are from a capital perspective, thinking out let’s say through the end of next year what your needs might be?
Bill Scheffel
I think with respect to Kentucky, we are committed to maintain the required capital levels in Kentucky through our exit, which would be July of 2013. There’ll be some runoff that has to occur for several months.
Typically, we’ve had this experience in a couple of states, we will get our statutory capital back at the end of the period when we’ve paid down most of the claims and worked with a particular department of insurance for purposes of paying back dividends. I think with respect to our overall capital needs, as we said, right now we are maintaining a 350% RBC level.
In the rest of our book of business we forecast out our requirements based on the large growth that we’ve had, and we continue to believe that we have available to us through both earnings and our credit lines sufficient capital to meet our requirements in the near term.
Justin Lake – JP Morgan
Okay. And the near term would be for the end of next year?
Michael Neidorff
Yeah. I think you look out over the next few quarters and I think you’ll – there are other RFPs coming up.
So based on what is known today, it’s different near term, that’s fine. That’s a quarter or two.
As we add new business, then we look at it, and we look at our debt capacity, because we obviously prefer debt, and we’ll continue to work with that basis in cash flow from our operations, which have thrown off decent cash. So I think to get beyond that, we may have more clarity in December.
I would hope we have several RFPs pending, so all that will influence us. So trying to speculate beyond that gets precarious and can mislead.
Justin Lake – JP Morgan
Okay. Can I just ask one follow-up and I’ll jump off?
Michael Neidorff
Sure.
Justin Lake – JP Morgan
The – thinking about the fourth quarter, where you are now versus what you were – what you were talking about after Q2, the – in the second quarter I think you had told us the 70% number, and that obviously included the Kentucky losses. So if we just assume they were about $0.20 for the run rate and call that the ex-Kentucky number would’ve been $0.90.
Right now you’re guiding to a midpoint of about $0.75, and I know there’s about $0.04 of headwind from the Kentucky exit. But that still leaves us about a dime short.
And I’m just wondering if you can identify what that dime was. I think it relates back to Pete’s question.
I just want to make sure I’m clear on it. Is there some higher tax rate or is there any other higher tax rate or is there any other one-time item there?
Because you’re talking about operations being better and yet it looks like there’s something missing there.
Bill Scheffel
I think most, if not all of the differential is related to Kentucky. I think as we were preparing our calculations for the second half of 2012 when we made our presentation in June there was an assumption that what was going to be happening in Kentucky during the course of the year.
There would be certain improvements. We were going to get a rate increase July 1.
And so I think the basic issue is you’re probably overestimating how much we had in the fourth quarter for the Kentucky loss. So, when you added $0.20 back to $0.70 I don’t know that that was a good starting point for a run rate.
Justin Lake – JP Morgan
Okay. So it was probably closer to $0.10 than $0.20 in your mind.
Bill Scheffel
I think that I – I think that’s more reasonable.
Justin Lake – JP Morgan
Okay. Great.
Perfect. Thanks a lot.
Operator
The next question comes from Scott Fidel of Deutsche Bank. Please go ahead.
Scott Fidel – Deutsche Bank
Thanks. Just wanted to continue on that topic, and just relevant to the 4Q.
So should we basically assume that there’ll be around a $0.23 contribution from the beginning of the reversal of the premium deficiency accrual? So if we take around one third of what you’ve approved in the third quarter?
Bill Scheffel
Yes. I think that’s a reasonable assumption.
And I think from our calculations that would for the most part cover Kentucky. It may not cover the exit costs, which we talked about being $0.04 in Q4.
But for the rest of the operations the reversal of the premium deficiency reserve in Q4 should cover the estimated operating loss in Kentucky.
Scott Fidel – Deutsche Bank
Okay. And then how should we think about days and claims payable in the fourth quarter, just given that you’ll start to drawdown some of that accrual?
Should we think about DCP coming down? Or are there additional claim reserves that you’ll be establishing that will offset that?
Bill Scheffel
Well, the DCP number that we provided excluded the impact of the expense and the reserve for the PDR. And so I don’t know that that number would change drastically.
It goes up a day or down a day in any quarter. So I wouldn’t expect to be any significant change from Kentucky being in there until next summer, if that causes any impact in the overall DCP numbers.
So I would expect it to stay in the same levels we are, which is the low 40s.
Scott Fidel – Deutsche Bank
Okay. Got it.
So core DCP should be in the low 40s in the fourth quarter?
Bill Scheffel
Yep.
Scott Fidel – Deutsche Bank
Okay. Then just a separate topic, just interested in what if anything you guys have been hearing around the industry tax?
And how that will be addressed, either from the states or the federal government on any developments in terms of how they’re thinking about building in the industry tax into Medicaid rates in 2014?
Michael Neidorff
We’ve had our Washington office has had multiple conversations, both sides of the isles, both houses. They understand the issue.
I think there’s a lot of issues. If the ACA stands, the outcome of the election, and you’re not getting a lot of people committing one way or the other, but they clearly understand it.
There’s a large group that have signed onto the necessary modifications. But we can talk more about it when we get through the election in Q1 of next year, because I think no matter what happens, both sides will agree that if ACA stands, there’s a lot of changes that need to be made to it to get it sustainable.
Scott Fidel – Deutsche Bank
Okay. And then just one last question, on the ABD MLR, it looked like that continued to creep up to 97.3%.
Do you have what that is excluding Kentucky? And really just interested here, because obviously mix of business wise ABD will continue to grow, especially as we get into the dual.
So just wanted to know what’s putting the upward pressure on the ABD MLR? Is that all Kentucky?
Or is that still some of the effect of Hidalgo? Or are there any other markets as well that are pushing the ABD MLR?
Thanks.
Bill Scheffel
I think it’s both. The Kentucky is in the overall number, because there’s quite a bit of SSI in there.
I think Hidalgo is also, increase is the overall number compared to what we have in other states. So those two items probably account for most of the differential.
Scott Fidel – Deutsche Bank
Okay. Thank you.
Operator
The next question is from Carl McDonald of Citigroup. Please go ahead.
Carl McDonald – Citigroup
Thank you. The open enrollment period in Kentucky just ended three days ago.
I’d be interested if you have any update on what your membership will look like in the fourth quarter? If not, the membership that you’ve assumed in setting the premium deficiency reserve for fourth quarter and first half of next year?
Bill Scheffel
I don’t think we have insight at this point in time in terms of any real changes in the membership numbers as the result of open enrollment. In our premium deficiency reserve calculations, we did not assume that there would be a significant decrease in membership between now and the end of June.
Anything is possible, but our calculations did not take that into account.
Carl McDonald – Citigroup
Okay. Second question would be just the thought process a quarter ago in not disclosing the $50 million premium deficiency reserve that you’d established in Kentucky.
I recognize it was just for the Health Plan business rather than consolidated Kentucky, but $50 million a decent size number also a pretty high profile topic. I wanted to understand the thinking around that?
Bill Scheffel
The premium, we have premium deficiency reserves for statutory purposes in several of our plans from time to time. We’ve never really talked about what a statutory PDR calculation or what that implies, because there’s a number of things that go into that that wash out in the consolidation.
So we look at it always from a GAAP standpoint, and that’s what we disclose on. So if we have a premium deficiency reserve for GAAP purposes, we would disclose that.
This is really I think the first time we’ve had a GAAP premium deficiency reserve, which was for Kentucky, and we discussed this I do believe at the end of the second quarter. We looked at that for purposes, and at that point we presumed over the life of the contract we would still break even.
Obviously the results in the third quarter worsened and it didn’t appear that there was going to be any improvement, and we’ve taken the actions that we have taken, and as a result of that, we did our calculations again in the third quarter and recorded the amounts that we did at this time.
Michael Neidorff
I think what’s also important, Carl, is right up until the point in time that we announced the PDR, we were in discussions with the state on some changes to the program that had they agreed to would have completely turned around the way things are done, not just for us, but for everybody to get that sustainable program. So as a result, there were some things we thought were particularly ourselves, but typically so – once we saw that those were going nowhere we very quickly calculated the PDR and got it out.
Carl McDonald – Citigroup
The $200 million in capital contributions that you’re expecting to make in the fourth quarter, is that just for new markets? Or does that include capital that we go into Kentucky as well?
Bill Scheffel
That would be for all markets. Some of that’s for Kentucky.
A lot of it would be for Texas, where given the significant growth in Texas as we increase our trailing 12 months revenue that statutory requirement goes up every quarter.
Carl McDonald – Citigroup
And then to follow on Justin’s question, any sense at this point of how much of that $200 million will come from ongoing operations or existing cash versus what we should expect for a debt increase in the fourth quarter?
Bill Scheffel
Well, at this time we don’t project out what our borrowings will be from quarter to quarter. We do believe we’ll have a significant level of earnings in Q4 and that we would be able to have availability on the revolver to fund the differential there.
Michael Neidorff
With some cushion remaining. It’s not a case of running the debt to the maximum.
So, we still are in a – we’ll be in a strong balance sheet position at the end of the year, is our forecast.
Carl McDonald – Citigroup
Okay. Thank you.
Operator
The next question comes from Dave Windley of Jefferies & Company. Please, go ahead.
David Windley – Jefferies & Company
Hi. Thanks for taking the question.
Michael, in your prepared remarks you made a brief comment relative to learning from Kentucky and not – being more wary about states moving populations into Managed Care first time. I wondered if you could expound on how that influences your thoughts about pursuit of RFPs in the future.
Is it simply only states that are moving populations in for the first time or what other learnings could you draw from this that might affect what you go after?
Michael Neidorff
Oh, yeah. I have to be very careful here, because I don’t want to – I’m not representing my complaint publicly over a conference call.
But I think there are a couple of things. You have to – you want great assurance that the data they’re giving you is complete and full.
And so, we typically have done that. There is a standard of practice the way things have been done that has not been an issue up to this point in time.
And as I indicated to you, this went very fast. The RP I think came out in May and they went live in November 1.
And typically states will do it on a more extended basis, getting things right through discussions and I think I eluded to it before, the fact that Ohio is – where they’ve had Managed Care, they’re a new population and they’re extending the period over time to get some things right and have those discussions. I think that’s what you want to see.
You want to see people that are working to – building sustainable programs versus having a program. And I don’t go beyond that because I – as I said, we’re going to take the high road on this thing.
And there is – and I – let’s just leave it at that.
David Windley – Jefferies & Company
Okay. So apart from Kentucky, do you – as you look at your business development efforts, do you have thoughts that you need to expand that, bulk that up, to handle the amount of the pipeline.
In other words, is there a process in capacity that you need to expand to be able to handle the expanse of opportunities that are out there?
Michael Neidorff
It was not – it was at no way, shape or form a capacity issue on our part. If you look at number of states that we have entered and you look at how we’ve done two, three states at one time, and more, we’ve had no issues.
So this is not a capacity. This is just a very particular issue for Kentucky.
And Louisiana, Mississippi, Illinois, I mean all the states that we’ve entered very successfully, to the state’s satisfaction as well as ours.
David Windley – Jefferies & Company
Got it. If I could ask one last follow-up on the shift to Texas.
You’ve made some nice progress there. It sounds like more than you expected.
Do you think that that progress can continue? Or are there any structural impediments that would cause that to plateau in the short-term?
Michael Neidorff
We still have a very strong team there. We continue to meet with the state on issues, when and if we identify them there.
They’re very interested in ensuring that the program continues to work and that they recognize the need for the companies to be successful in doing it, to have programs. So I see no issues there.
I think we said in our script that we anticipate it continue to normalize going into 2013.
David Windley – Jefferies & Company
Okay. Thank you.
Michael Neidorff
Thank you.
Operator
The next question comes from Brian Wright of Monnes, Crespi & Hardt. Please go ahead.
Brian Wright – Monnes Crespi & Hardt
Thanks. Good morning.
I just wanted to get a – so if the $0.70 to $0.80 of a fourth quarter guidance includes $0.23 for the release of the premium deficiency from Kentucky, that’s a bit lower than your x-Kentucky run rate in the second quarter. You’d spoken to $0.09 of it, I believe, in Kentucky run off and higher Kansas G&A.
But there’s still a delta there. How much of that delta is seasonal MOR higher in the fourth quarter versus a tax rate catch-up issue in the fourth, to get to the 40% for the full year?
Bill Scheffel
I think, Brian, that the – you said, second quarter, I don’t know if you meant third quarter.
Brian Wright – Monnes Crespi & Hardt
Sorry, yeah, I meant third. Sorry about that.
Bill Scheffel
Okay. Good.
Good. That’s a little easier to – the issue there is we said we had $0.31 of operating loss in Q3 and that was exacerbated by additional adverse development, let’s say, from prior in the years as we continue to receive more retros coming from that.
So I think what we’re seeing is we don’t expect Q4 to be at the $0.34 run rate going forward, more closely aligned to the $0.23 which reverses off of the PDR. And I think the differential, we’d planned for a lesser amount in Q4 when we were trying to reconcile the guidance numbers in total, but we do believe that the numbers that we’re giving right now, Q3 and Q4, the $0.78 that we have for Q3 and then the $0.70 to $0.80 range for Q4 adjusted for business expansion costs and for the exit costs in Kentucky, and a little bit higher HBR in Q4 versus Q3, are the primary moving parts for the reconciliation.
Taxes really don’t play much of a part in either quarter. They’re about the same.
Brian Wright – Monnes Crespi & Hardt
So your view is that that’s not a material difference run rate?
Bill Scheffel
For which piece?
Brian Wright – Monnes Crespi & Hardt
For the fourth?
Bill Scheffel
Yeah. I think third and fourth quarter are comparable in many respects when you adjust for just a few items.
Brian Wright – Monnes Crespi & Hardt
Okay. Thank you.
Michael Neidorff
We have time for a couple more, then...
Operator
The next question comes from Scott Green of Bank of America Merrill Lynch. Please go ahead.
Scott Green – Bank of America Merrill Lynch
Hi. I appreciate the questions.
On Kentucky, I was just curious if you could tell us what the MLRs would have been in second quarter? And then third quarter, if you reallocated the unfavorable development to the appropriate periods?
Bill Scheffel
I’m not sure I have all those, but I would say we ran 115% in Kentucky in Q3 and it would have probably been closer to 109% and 110% without the adverse development. All those numbers without a PDR, those are the before numbers.
Scott Green – Bank of America Merrill Lynch
Okay. And I believe the statutory filing in the second quarter was 119, but that assumed a little unfavorable development, so it may be closer to 112.
Is it safe to say that you got a little bit of improvement sequentially in Kentucky on a run rate basis?
Bill Scheffel
I think it’s dangerous to compare statutory numbers and GAAP numbers when you’re picking up PDRs in one and not in the other. So I think I’ll leave it as I just explained.
Scott Green – Bank of America Merrill Lynch
Okay. I guess I wasn’t clear.
So not referring to the stat filing, do you think the trend in Kentucky ex favorable development improved sequentially?
Bill Scheffel
They’re about the same. There’s not much difference either way.
Michael Neidorff
As we said, we’re still getting retro adds going back to next November. So tell us how many of those we are going to get next month, we could give you a sense.
That’s part of the issue. That’s one of the big issues.
Scott Green – Bank of America Merrill Lynch
Okay. Separately, in Texas, you said you had a mid-90s MLR.
Just hoping you could offer a bit more detail since September 1 was the big rate increase that’ll help the MLR going forward, could you tell us maybe what the MLR was in the September period with the rate increase? Was it lower than the average of mid-90s?
Michael Neidorff
We’d much rather do it on a quarterly basis where we look at the prior period evolved maybe on a quarterly basis. So I think, Bill, it would be misleading trying to give one month.
Bill Scheffel
Yeah, and I think in general we’re just trying to show that, with respect to Hidalgo, it started March 1, we’ve had quite a few months to try to work on the utilization levels, and then we also picked up new membership in August and September, we got a rate increase in September. So, all those things considered, we still operate in the mid-90s and our team is working very hard there to try to continue to bring down the utilization levels in that service area, which is still much higher than they are in the rest of the state and is – will continue to be a work in progress probably for several quarters.
Michael Neidorff
Recognize that we took on, what, 9,000 lives in August and September of high intensity and we’re managing it down to that level. That’s important.
Scott Green – Bank of America Merrill Lynch
Okay.
Michael Neidorff
One more question and then (inaudible).
Scott Green – Bank of America Merrill Lynch
Sure. Could you elaborate on the Georgia revenue issue you called out?
Was that a new thing related to what AmeriGroup talked about in the second quarter of last year with membership reconciliations? And do you expect any true-up from the state from this going forward?
Bill Scheffel
It is a similar issue that all three MCOs have to deal with in the State of Georgia in terms of how the state processes membership, retroactive membership deletions, primarily from what they consider to be duplications, and there’s – it takes a while for them to process these. We make accruals for these on a regular basis every month.
From time to time there’s a true-up that might occur, which is particularly what happened in 2011, and then there’s some adjustments in terms of how that impacts actuarial soundness and rates. And so, during the quarter there was – Georgia made some adjustments and we, in those amounts, and we reflected that in the quarter.
Scott Green – Bank of America Merrill Lynch
Okay.
Michael Neidorff
It’s always routinely looked at every month. Okay.
We have one more?
Operator
The final question comes from Michael Baker of Raymond James. Please go ahead.
Michael Baker – Raymond James
Thanks a lot. I was wondering if you could give us some color on the – when the Ohio duals are coming, what are you doing in advance of that as it relates to medical management outreach, particularly in light of what you’ve learned on other dual processes so far.
Michael Neidorff
Well, I think keep it somewhat limited. We’ll get what data we can and we’ll do it through our predictive models.
We’ll use our system capability to examine what needs to be done and we’ll work with the state and see what information we can get on the history of these people, and just ensure that there’s a solid – the medical management people work on a solid transition plan and ensure that they gain the benefits they should for Managed Care. The state’s working very closely with us on that.
Michael Baker – Raymond James
And are there any differences in how you’re approaching, you’re reserving assumptions in front of it in light of what experience has been to-date on the duals?
Michael Neidorff
Well, we can’t take reserves until we have the members with the...
Bill Scheffel
No, I mean it’s – we try to reserve for the expected costs for each individual population and this population will continue to be looking at to determine what we think the – once we get rates and expected HBR is and we’ll try to conservatively accrue that and normally we’ll try to build margin up in the first six months of operations of a new area or segment of a population. I’m sure that will be the case in Ohio.
Michael Baker – Raymond James
Thanks.
Bill Scheffel
Thank you.
Michael Neidorff
We thank everyone and we look forward to the December 14th guidance and the year-end call in February. Thank you so much.
Have a good day, everybody.
Operator
The conference is now concluded. Thank you for attending today’s presentation.
You may now disconnect your line.