Jul 29, 2009
Executives
Angela F. Braly - President and Chief Executive Officer Wayne S.
Deveydt - Executive Vice President and Chief Financial Officer Ken R. Goulet - Executive Vice President and President of Commercial Business Unit Brian A.
Sassi - Executive Vice President and President of Consumer Business Michael E. Kleinman - Vice President of Investor Relations
Analysts
Justin Lake - UBS Chris Carter - Citi Joshua Raskin - Barclays Capital Matthew Borsch - Goldman Sachs Doug Simpson - Morgan Stanley Scott Fidel - Deutsche Bank Securities Christine Arnold - Cowen Investments Thomas Carroll - Stifel Nicolaus & Co. Carl McDonald - Oppenheimer & Co.
Ana Gupta - Sanford Bernstein Co.
Operator
Ladies and gentlemen, thank you for standing by and welcome to the WellPoint Conference Call. At this time all lines are in a listen-only mode.
Later, there will be a question-and-answer session, and instructions will be given at that time. (Operator Instructions).
As a reminder, this conference is being recorded. I would now like to turn the conference over to the company’s management.
Michael E. Kleinman
Good morning and welcome to WellPoint's second quarter earnings conference call. I'm Michael Kleinman, Vice President of Investor Relations.
With me this morning are Angela Braly, our President and Chief Executive Officer; and Wayne DeVeydt, Executive Vice President and Chief Financial Officer. Angela will begin this morning’s call with an overview of our second quarter results, actions, and accomplishments.
Wayne will then offer a detailed review of our second quarter financial performance and current guidance which will be followed by a question-and-answer session. Ken Goulet, Executive Vice President and President of our Commercial Business and Brian Sassi, Executive Vice President and President of our Consumer Business are available to participate in the question-and-answer session.
We will be making some forward-looking statements on this call. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of WellPoint.
These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to review the risk factors discussed in our press release this morning and in our quarterly and annual filings with the SEC.
I will now turn the call over to Angela.
Angela F. Braly
Thank you, Michael, and good morning. Today, we are pleased to announce second quarter 2009 net income of $694 million or $1.43 per share.
This included net investment losses of $0.07 per diluted share. This compares to net income in the second quarter of 2008 of $751 million or $1.44 per share which included net investment losses of $0.03 per share.
We now expect our full year 2009 earnings per share to be $5.06 to $5.12 including net investment losses of $0.54 per share. Our updated guidance reflects an improved outlook for our consumer business and in the capital management areas of our company, partially offset by a more cautious outlook for the commercial segment.
Results in our consumer segment have improved significantly from last year and are running ahead of our plan due to certain operational and strategic actions we’ve implemented over the last several quarters. Our commercial business, however, is clearly being impacted by the economic downturn, and my leadership team and I are diligently managing this business during these challenging times.
The economic impact is most apparent in our enrollment levels. Medical membership fell by 338,000 in the quarter, almost equally split between fully insured and self-funded business.
Our customer retention levels remain strong and generally consistent with historic levels at nearly 90% overall. However, we continue to experience negative in-group change which is membership loss within our continuing group customer base that is primarily related to work force reductions.
Negative in-group change impacted commercial membership by 254,000 members during the second quarter. More than 75% of the year-to-date commercial membership decline we’ve experienced is directly related to the economy as reflected by our negative in-group change of approximately 500,000 lives since December 31, 2008.
This was the primary reason that our national business declined by 154,000 members in the quarter. Blue local group business declined by 109,000 members in the quarter, and our non-Blue unit care and HealthLink business declined by 57,000 members.
The unemployment rate in our Blue states is currently just under 10%, and we expect unemployment to trend higher in the coming months and exceed our previous projections. We are taking a cautious view of the economy, and this is the primary reason that we have lowered our year-end membership expectations to 33.6 million.
To address the needs of our members and to keep more members covered under our plan, we are expanding our state covered programs. This initiate helps our commercial members who have lost their employer-sponsored coverage enroll in one of our individual plans and educates members nearing retirement age about our Medicare products so that they can continue to receive the quality coverage they have come to expect from us.
We are also advancing our retail healthcare strategy recognizing that consumers have knowledge, choice, and control over healthcare interactions regardless of whether they purchase coverage through their employer or individually. We understand that companies who meet the needs of customers can win in both the employer and consumer markets, and we intend to emphasize the value we bring to healthcare by putting the customer first.
It is important to note that we continue to win in the commercial marketplace. We are in the midst of the 2010 national account selling season, and we are having a solid sales year with 14 new or expansion sales totaling well over 500,000 members.
We expect to continue to see job losses impacting our national account customers, which will impact this number; however, we anticipate a strong selling season for 2010. These groups recognize our unique industry-leading value proposition of broad network, superior discounts, and good service.
There are still large groups in the process of making decisions for 2010, and we may see even more large-group wins in the near future due to our best in class value proposition. Overall, the marketplace remains competitive but generally rational, and we are seeing pricing firm from some of our competitors.
Operating revenue totaled $15.3 billion in the second quarter of 2009, a slight decrease of less than 1% from the first quarter of 2009. The decline reflected the impact of lower fully insured enrollment offset by disciplined pricing and higher administrative fee revenue.
The benefit expense ratio was 82.9% in the second quarter of 2009, a decline of 40 basis points from 83.3% in the prior year quarter. The decrease was driven by the consumer segment and included higher than anticipated favorable prior year reserve development.
The consumer benefit expense ratio also improved due to operational improvement in the senior and state-sponsored businesses. We implemented changes to our Medicare Advantage product portfolio and pricing for 2009 and have exited certain state-sponsored programs for which we were unable to obtain actuarially sound rates.
The local group benefit expense ratio rose in the second quarter of 2009 from the second quarter of 2008, mostly due to California and Ohio, two of our Blue states hardest hit by the recession and both experiencing unemployment in excess of 11%. We are seeing harder benefit-expense ratio from a change in business mix as employers have responded to economic conditions.
We are finding that lower utilizing employers are disproportionately losing or dropping coverage, leaving a higher percentage of other employees enrolled in our product. This has contributed to a slight increase in utilization.
We will price for this phenomenon as groups renew and expect to see improvement in commercial underwriting results as these groups renew. Group canceling coverage continues to have a higher aggregate benefit expense ratio than groups renewing with us.
As the unemployment rate rises and given the changes to COBRA funding as part of the stimulus package, we are also seeing more COBRA members. COBRA membership has risen from approximately 1.6% of our fully insured enrollment as of year end 2008 to 2.2% currently, which is higher than we had anticipated.
The additional election period for individuals eligible for the 9-month subsidy ended in June, and our guidance includes higher expenses for these COBRA members. Also, while flu was not a major driver of our second quarter of 2009 results, we are seeing elevated flu-related claims during a time of the year when we would normally expect minimal flu activity.
Consequently, we have included in our guidance provisions for a higher than average flu season later this year. While commercial’s results are lower than we expected this quarter, we are taking appropriate action and believe we have appropriately reflected the business mix changes and utilization patterns in our June 30, 2009, reserve level and our outlook for 2009.
We continue to price our business for a slight increase in medical cost trends this year. I’d now like to turn to healthcare reform.
The issues with healthcare in today’s economy call for thoughtful, sustainable solutions. As the nation’s leading health benefits company, we have real world proven solutions to share.
We actively support a call for all Americans to have health coverage and to pay for it through shares responsibility for those who have financially able to do so and through subsidies for those who are not. We believe that a government plan is unnecessary, and we urge Congress to take the opportunity to fundamentally address the underlying causes of rising healthcare costs.
Managed care organizations are the component of the healthcare system that has the best ability to favorably impact the cost curve. WellPoint is currently advancing strategies to improve quality, manage costs, and improve insurance coverage, and by working together with the government, employers, and providers, we can build a healthcare system that is accessible to all and provides quality care for those who need it most.
One way that WellPoint improves quality and adds value to healthcare is through programs like Anthem Care Compare. Care Compare is a tool on our Anthem website that displays the cost and quality information on many medical procedures.
A member who has this information can have a better conversation with their doctor about where to have the procedure and what it will cost. This tool harnesses the unique steps of the claims data we have from our leading market position in most geographies into a consumer transparency tool that is desired by both employers and members.
We recently expanded Care Compare to two more large blue plans and Care Compare will now become the new blue standard for cost and quality transparency. The endorsement by the Blue Cross and Blue Shield Association will bring even more states on board and ultimately provide nearly 100 million Americans in all part of the Blue Cross and Blue Shield system with access to this industry-leading tool.
The expansion will also enhance the Blue Advantage in marketing to national accounts and other customers by providing what we believe is the best consumer cost and quality tool available. Another way we add value to healthcare is through strategic alliances that lower costs and provide the best service to our customers.
Our proposed transaction and 10-year contract with Express Scripts is an industry-leading example of how we can reduce medical costs through volume purchasing and improve the quality of healthcare. We will continue to provide an integrated offering to our members, who will also have access to Express Scripts’ superior web capabilities.
This transaction is progressing as planned, and we expect it to close in the fourth quarter. We continue to work on detailed transition plans which include member migration strategies and timing.
Our first priority is to provide a flawless migration for our members. Before I turn the call over to Wayne, I want to briefly discuss our Building a Better WellPoint program that’s currently under way to improve our work processes and serve our members more effectively and efficiently.
Through Building a Better WellPoint, we have launched specific initiatives involving cost center effectiveness, claims processing, information technology, training and professional development, underwriting, and utilization management. These initiatives to optimize our performance and customer service represent only the start of our work on building even a better WellPoint for the future.
I’ll now turn the call over to Wayne DeVeydt for a detailed look at our second quarter financials and updated guidance.
Wayne S. Deveydt
We had a solid quarter in the consumer segment and in the capital management areas which helped offset the economic impact experience by our commercial segment. Premium income was $14.1 billion in the second quarter of 2009, a $222 million or 2% decrease from the prior year quarter, primarily due to fully insured membership declines in our commercial business and our exit from certain state-sponsored programs including the Ohio Medicaid program.
These decreases were partially offset by premium rate increases and increased reimbursement in the FPP program. Administrative fees were $977 million in the second quarter of 2009, up $11 million or 1% over the prior year quarter, primarily due to revenues generated by DeCare following our acquisition, self-funded membership growth in national accounts, and improved pricing in local groups self-funded accounts, partially offset by lower revenues in national government services business and our exit from the Connecticut Medicaid program.
Despite the significant increase in unemployment and due to our diverse membership base, we had only a slight decline in operating revenue of approximately 1%. As Angela noted earlier, our benefit expense ratio decreased by 40 basis points to 82.9% in the second quarter of 2009 from the prior year quarter.
This was due to higher than anticipated prior year development and operational improvements in our consumer reporting segment, partially offset by an increase in the benefit expense ratio for the commercial segment. We now expect our benefit expense ratio to be 82.9% for the full year of 2009, an increase of 20 basis points from our prior guidance.
This updated forecast reflects the estimated impact of the economy, expected utilization pattern including an increase in COBRA related expenses, and an expected elevated flu season later this year, partially offset by an improved expectation for the consumer business. Directionally, the benefit expense ration in the third quarter of 2009 is expected to be lower than in the fourth quarter.
For full year 2009, we continue to project that underlying local group fully insured medical cost trends will increase from 2008 but remain within the range of 8% plus or minus 50 basis points. Unit cost increases continue to be the primary driver or medical cost trends; however, we have seen a slight increase in utilization through the first 6 months of 2009.
As a result of this observation and expectations for elevated flu-related claims this fall, we now believe that full year medical cost trend will be closer to the higher end of the guidance range. We continue to prior our business so that expected premium yield exceeds total cost trend, where total cost trend includes medical costs in selling, general, and administrative expense.
Inpatient hospital trend is in the low double-digit range and is 90% related to increases in cost per admission. Unit costs are rising due to an elevated average case acuity and higher negotiated rate increases with hospitals.
Our efforts continue to result in significant discounts with our providers. We’re also placing additional focus on high-cost facilities and on certain services such as neonatal intensive care, spinal surgery, and end-stage renal disease cases.
Cost transfer outpatient services are in the low double-digit range and are about 75% unit cost-driven and 25% utilization. We utilize medical management programs and are optimizing site of service decisions such as for outpatient surgery by helping members determine whether it is more advantageous to have surgery in a hospital versus an ambulatory surgical center.
We continue to expand radiology management through out American Imaging Management or AIM subsidiary. We are expanding AIM’s platforms to nuclear cardiology and specialty pharmacy reviews.
Physician services trend is in the mid single digit range and is about 55% unit cost driven and 45% utilization. We use fee schedules to contract with many physicians and are collaborating with physicians on pay for performance initiatives.
We paid more for improvements in clinical results, and in this quarter, we initiated patient-centered medical home programs in Colorado and New Hampshire. Pharmacy trend is in the mid single-digit range and is 90% unit cost related and 10% utilization-driven.
We are continuing our efforts to increase generic and mail order penetration and expect that our new strategic alliance with Express Scripts will favorably impact pharmacy cost trends next year and over the life of the contract. Selling, general and administrative expense was $2.3 billion in the second quarter of 2009, an increase of $125 million or 6% from the prior year quarter primarily due to higher overall compensation and technology and service costs, partially offset by lower selling expenses.
Our SG&A expense ratio increased 100 basis points to 15.4% in the second quarter of 2009 from the same quarter in 2008. The increase in our SG&A expense ratio was primarily due to the higher costs just mentioned.
Turning now to our segments, commercial operating revenue was $9.3 billion in the second quarter of 2009, a decrease of $177 million or 2% from the prior year quarter. This was primarily due to fully insured membership declines in our local group, unit care, and national businesses as well as revenue declines associated with our life and disability ancillary products.
These decreases were partially offset by premium rate increases, increased revenue from DeCare following our acquisition, and higher membership in our self-funded national business. Operating gain decreased $264 million or 31% to $583 million in the second quarter of 2009 from the prior year quarter, primarily due to lower operating revenue resulting from economy related fully insured membership declines, a higher benefit expense ratio in our local group businesses particularly in California and Ohio, and higher overall administrative costs.
Consumer segment operating revenue decreased by $54 million, or 1%, to $4.1 billion in the second quarter of 2009 from the prior year quarter, primarily due to our exit from certain state-sponsored programs for which we were unable to obtain actuarially sound rates including the Ohio Medicaid program. Operating gain increased to $154 million, or 68%, to $382 million in 2009, primarily due to improved results in our Medicare Advantage and state-sponsored businesses and higher than anticipated favorable prior reserve development.
Net investment income was $206 million in the second quarter of 2009, $12 or 5% lower than the prior year quarter due to reduced investment balances as a result of our share repurchase program and lower yields on short-term investments. Net realized gains of $16 million in the second quarter of 2009 were primarily driven from the sale of fixed maturity securities.
Additionally, we adopted the FASB provisions providing new guidance on the recognition and presentation of other than temporary impairments or OTTI of fixed maturity securities. Under this revised guidance, we recognized OTTI losses of $74 million, primarily in fixed income securities in the second quarter.
We also recorded a favorable cumulative effect adjustment net of taxes of $89 million to reclassify the non-credit component of previous OTTI impairments from retained earnings to accumulated other comparative income. The overall investment portfolio continued to perform well in the second quarter as the portfolio increased by more than $365 million in after tax value as a result of the recovery in the capital markets.
Income tax expense decreased $77 million or 18% to $359 million in 2009. The effective tax rates in 2009 and 2008 were 34.1% and 36.7% respectively.
The 260 basis point decrease in the effective tax rate in 2009 was primarily due to a decrease in overall state taxes and the volatility in our tax sensitive investments. We are incurring lower state income taxes in New York this year as a result of the state deficit reduction plan which are basically being offset by higher administrative expenses in New York due to state assessments.
Turning now to our medical reserves. We have included in our press release a reconciliation and roll forward of our medical claims payable reserves.
This disclosure is comparable to the reconciliation provided in our fourth quarter 2008 press release. We report prior year redundancies in order to demonstrate the adequacy of prior year reserves.
Medical claims reserves established at December 31, 2008, continued to develop favorably. For the six months ended June 30, 2009, we had significant positive prior year reserve development of $720 million.
As expected this level of positive reserve development is significantly higher than the $270 million we experienced for the first six months ended June 30, 2008, and further demonstrates that we addressed the claims visibility issues we experienced in the end of 2007 following certain system migrations. Year to date through June 30, 2009, we recognized an estimated $100 million of higher than anticipated prior year reserve development predominantly in the consumer segment.
We continue to establish reserves in a conservative manner and believe that our June 30th reserves are appropriately stated. Days in claims payable as of June 30th 2009 was 45.9 days, a decline of 1.8 days from 47.7 days as of December 31, 2008, and June 30, 2008.
The decrease in DCP reflected lower medical claims payable resulting from the reduction in claims inventories, lower fully insured enrollment, and the favorable prior year reserve development. Our claims inventory as of June 30, 2009, has declined 39% from June 30, 2008, and has continued to trend downward this year declining by 24% since year end 2008, mostly in the second quarter.
We are delivering better customer service through faster claims payments to doctors and hospitals, and this is giving us even better visibility into claims trend. At June 30, 2009, our subsidiaries remained very well capitalized, with statutory capital $5.6 billion higher than state regulatory requirements and approximately $2.4 billion higher than Blue Cross and Blue Shield requirements.
Cash flow from operations year to date through June 30, 2009, was approximately $1.6 billion, or 1.2 times net income. We continue to expect more than $2.9 billion in operating cash flow in 2009.
As of June 30, 2009, we had approximately $1.4 billion of cash and investments held at the parent company and available for general corporate use. This is up from approximately $1 billion at the end of the first quarter, as we received $864 million in dividends from our subsidiaries in the quarter and repurchased $437 million of shares during the quarter.
During the quarter, we also reduced debt by $166 million. Our debt-to-capital ratio ended June at 29.2%, down from 30.3% at the end of the first quarter.
During the second half of 2009, we expect to receive $1.5 billion in ordinary dividends from our subsidiaries. Year to date through June 30, 2009, we have repurchased 27.4 million shares or 5.5% of our shares outstanding at the end of 2008 for approximately $1.1 billion or an average of $40.77 per share.
We have approximately $1.4 billion of share repurchase authorization remaining as of June 30, 2009, and this does not contemplate any share repurchase from the proceeds of the Express Scripts transaction. We expect to repurchase $2 billion in incremental shares following closing the Express Scripts transaction, subject to market conditions.
Let’s now turn to our updated outlook for 2009 which assumes no impact from the Express Scripts transaction. We now expect year end 2009 medical enrollment to be 33.6 million including 19.1 million self-funded customers and 14.5 million fully insured.
Note that our updated membership guidance reflects the expected conversion of an 840,000 member experienced rated low margin municipal account from fully insured to self funded status effective October 1, 2009. Operating revenue is now expected to total approximately $60.6 billion.
The benefit expense ratio is now expected to be approximately 82.9%. The SG&A expense ratio is now expected to be approximately 15.7%.
Earnings per share are now expected to be in the range of $5.06 to $5.12 on a GAAP basis which includes the $0.54 per share of investment losses year to date through June 30th and does not include any future investment gains or losses, and operating cash flow is now expected to exceed $2.9 billion for the full year of 2009. Overall, we’re pleased with our earnings per share results so far in 2009, but continue to have a cautious outlook for the full year.
I would also like to give a preliminary glimpse into potential headwinds and tailwinds into 2010. Among the headwinds are the following: Our senior bids are in for 2010, and we expect the Medicare Advantage program to create a headwind for us next year as margins are expected to be pressured due to CMS reimbursement changes.
While we do expect growth in our Medicare supplement book to offset some of this pressure, on a net basis, we expect senior to present an earnings headwind next year. If unemployment continues to keep ticking up as we expect it to do, this will create a headwind for us in 2010 as members we have lost during 2009 would no longer contribute operating gain in 2010.
Also, we’re planning to make some infrastructure investments that will be expensed in 2010 and we will benefit in future years through lower costs. Finally, as noted earlier, our 2009 results to date have included an estimated $100 million of higher than anticipated favorable prior year development that is not expected to recur in future periods.
Among the tailwinds are the following: Approximately $2 billion of the proceeds from the Express Scripts transaction are expected to be utilized for share repurchases and another $500 million of the proceeds are expected to be utilized for debt repayment, both of which are again subject to market conditions. Both of these items would benefit EPS in 2010 and beyond.
As Angela noted earlier, we’re having a strong sales year in national accounts and expect solid net membership growth in that business again next year. Also products utilizing our newly contracted networks in Georgia and Virginia should be a positive catalyst for both commercial and individual sales and operating gain.
Finally, while we are not predicting an economic recovery in 2010, when the employment situation does improve potentially later next year, it should create a tailwind for us through better sales and positive in-group growth as employers expand their associate base. We are currently early in the process of developing a detailed business plan for 2010 and will provide more commentary about 2010 later this year.
I will now turn the conference call back over to Angela to lead the question-and-answer session.
Angela F. Braly
Operator, please open the queue for questions.
Operator
(Operator Instructions). Your first question comes from the line of Justin Lake - UBS.
Justin Lake - UBS
My first question is on the guidance change. It looks like if you back out the $100 million of positive development that wasn’t in guidance previously, you had something in the neighborhood of $300 million guide-down here.
Is there a number that you can talk to as far as walking us through what you’re building in there? You broke up the parts as far as flu.
Can you give us some more detail as far as where that $300 million comes from, and when specifically you saw the increase in trend that’s driving some of that especially since your cash flow was of positive in the quarter?
Angela F. Braly
Justin, I’m going to let Wayne take you through in a little more detail the $300 million that you’re talking about, but I want to say first given all the circumstances, most notably the unemployment, we really believe now is not the time to change our guidance, so as Wayne you takes you through this very explicitly, I think you just need to keep that in mind.
Wayne S. Deveydt
If you look at the $300 million, I would break it into two buckets; the first bucket being the first half of the year where we had the $100 million of reserved releases and really what’s driving the offset to that is the commercial fully insured member months represented about $70 million of that where we had deterioration beyond our expectations. As you know in our original guidance, we had assumed a 10% unemployment rate by the end of the year.
In our Blue states, that number is already up to 9.7% as of June 30. So, the member months are coming off at a faster pace than we expected in the first half of the year.
That obviously will tail off for the second half; nonetheless, it was part of the $70 million in the first half. In addition, for the first six months of the year, while the flu season was not a major driver, I think we all would agree we had somewhat of a more moderate flu season in the first quarter; I think there was a little bit of a swine flu panic, I would say, in the second quarter, but consolidated for the six months, it was only about a $20 million impact over our expectations; but that’s about $20 million of that $100 million.
Then, the other $10 million is really mix shift utilization that we really just started to see in the last part of this quarter, meaning specifically June. So, that accounts for the first $100.
If you looked then for our outlook, our outlook then for the other $200 million deterioration in operating earnings for the second half of the year really follows that same path. For example, if you start with the fully insured commercial membership months, we further reduced our guidance; we do think unemployment will be higher than 10% now, and we’re expecting that change to continue at a pace that it has been at.
So, we expect about $55 million of deterioration there just due to member months. The second piece is when you look at the flu season, typically by June, the flu is pretty much gone and it’s still not gone yet.
So, we are anticipating for the second half of the year maybe an additional $20 million beyond normal expectations for the flu, and then there’s about a $125 million that is COBRA related and mix shift related, and I say that’s about half and half right now. So, half that would be the COBRA uptick that we would expect and the other half would be the mix shift as we continue to lose those members, but in theory, we believe, we may be losing some of the healthier members and that may shift.
In terms of timing, for that last component of COBRA and mix shift, it really did happen in the last part of this quarter. I would say, prior to that things were looking fine; we don’t want to necessarily say that one month is a trend, but I think in this environment and where unemployment is going, to try to determine historical behaviors are going to be the same for future behaviors I think would be an imprudent thing to do.
So, we’re taking a very cautious outlook for what we saw for a very slight uptick utilization for that one month, but we are going to look at that as if that will continue for the back half of this year.
Justin Lake - UBS
Just a quick followup then on that utilization uptick; can you give us any details as far as what you’ve seen so far; it sounded like this uptick happened in June. Can you tell what you’re seeing from your July utilization metrics and maybe cash flow that could tell us whether this is white noise or whether it looks like a trend.
Wayne S. Deveydt
At this point it’s hard to say; we haven’t closed out July yet, we are tracking a lot of different statistics that we have. We do see our days per thousand and outpatient visits per thousand are both up just ever so slightly right now, but in line with what I think we would expect.
Again, it’s early; cash flow can change quickly, but so far our cash flow seems to be holding in okay. Again, I don’t know that we want to declare anything though because I think things can flip within a month and I think that’s very evident in how good results look for us from our perspective just through the mid part of the second quarter.
So, I don’t want to say that it is white noise, but it very well could be, but again, I think the cautious outlook is really a priority right now. The other thing I would add and I am sure the question may come up is that relative to overall reserve position, I think it’s also very important to recognize that we believe at June 30th we have a very conservative balance sheet still, and we believe we’re reserving in a very consistent manner with our historical practices clearly based on the reserve grow-forward, I think many of you would have expected more than $100 million to be released; I think at this point we would prefer to maintain a cautious and conservative outlook and maintain that conservatism in the balance sheet; that is not included in any of our guidance.
So, if in fact things are better, that effect would fall too, but at this point, we think, being cautious is really the more prudent thing to do.
Operator
Our next question comes from the line of Chris Carter - Citi.
Chris Carter - Citi
Just wondering if you could remind us what the MLRs for the COBRA lives are?
Wayne S. Deveydt
The MLRs historically have averaged between 150% to 200%. So, if you take historical averages, which are generally trending closer to the higher end of that range, I think it’s fair to say that as new lives come on, they are not as high of a risk, but nonetheless, we still think that kind of a midpoint of where we think these lives are coming in at is around closer to 175%.
These are not good risk coming on to the book and that is part of the reason that we are taking it by the run rate perspective.
Chris Carter - Citi
So, the 175% is a good way to look at the new lives coming on to your book?
Angela F. Braly
Remember that they are not new lives, they’re existing group members who are electing COBRA and more of them are electing the COBRA given the subsidies; so what we’re saying is the whole population that we’re designing as COBRA members, typically it’s about 1.6% of our membership, which it was at December 31st; now it’s close to 2.2% of our fully insured members, and so those are existing members who are sticking around on COBRA who are utilizing and producing an MLR at that rate.
Operator
Our next question comes from the line of Joshua Raskin - Barclays Capital.
Joshua Raskin - Barclays Capital
One clarification; the $720 million win, are you saying that all but $100 million was replenished?
Wayne S. Deveydt
Josh, at this point in time we believe the vast majority with the exception of $100 million has been replenished. I think it’s important to recognize though Josh that at December 31st that balance had a higher fully insured membership base associated with it and higher inventories.
The theory is that as we pay down inventories as that membership base declines the absolute medical claims payable balance will come down, but it doesn’t mean that we’re being less conservative in the level of redundancy that we would expect. So, yes, Josh, we would like to believe that that would prove to be true and that we will see more conservatism come through in the latter half of the year.
Joshua Raskin - Barclays Capital
We can look at relative to medical costs, but I think that ratio was probably more important, but I guess just in terms of the cost trend expectations in the second half, I just want to make sure I understand what you guys are assuming; are you assuming because it doesn’t sound like there was higher than expected cost in the second quarter, it sounds like you are assuming a higher level in the second half, but is that an accelerating trend and is this based on June data specifically or the second quarter; some of the competitors have been talking about using more recent claims even though that’s not necessarily the most sound actuarial method because the new data seems to be coming in a little bit higher; I am just curious what exactly is that expectation. Then, sort of as a correlated question; why are healthy members losing insurance more than the sick members?
Angela F. Braly
Josh, let me speak to a couple of things. One is, we have really worked on the foundational operational improvement over the last 12 months and I think we’re seeing the benefit of it in terms of the claims inventories going down year-over-year almost 40% and this last quarter even in the 20% range, so we’re seeing the claims data on a faster basis.
I think we’re making or having better analysis as a result of that, and specifically we did see in the last month, as Wayne said June, some indications of trend ticking up which is why as we look out we say we’re expecting to be at the higher end of our range; the 8% plus or minus 50 basis points. In terms of whether or not we’re wading that differently, I wouldn’t necessarily think we’re doing that.
Our actuaries are looking at all the trends; they are also factoring in the fact that we have accelerated these inventory declines, and that’s frankly in our DCP coming down because we’re faster at paying clients. So, I think that gives us some more accuracy.
I think though as I said earlier, we think given the unemployment factors and what they may be contributing here, it’s time to be cautious and appropriate about what we might be seeing in trends as well as as we said the COBRA and the flu. In terms of the healthy members, why do we think the healthy members might be staying off; all I can go through what we’re seeing, we did kind of a member exit study around when group members leave, why is it that they’re leaving; it’s definitely driven by the economy, but he can give you a little bit of flavor there for why it is maybe that the healthy members might be dropping.
Ken R. Goulet
Josh, I can’t give in granularity exactly why the healthier members are leaving, but let me give you a couple of data points. First, we are looking very heavily at the macroeconomic trends and how they’re impacting the business, and the vast majority of our membership losses are due to the economy, over 75% of our member loss is due to job change and job loss.
When we look at the underlying factors of our business, our active canceled loss ratios are very favorable, meaning the members that are canceling and leaving us not due to economy but due to canceling our allowed to unknowns that we’re retaining is favorable in the way that we’re managing the business and have continued to manage it. Secondly, we feel that the age of our membership is not significantly impacted.
We’ve been tracking the age to see the demographics of our book and how that is impacting us and the age specifically has not changed more than it normally does. So, as we dig into it and look at our research, it does appear that our business mix shift has changed slightly and that’s primarily because of the member loss of those leaving us due to the economy and as we’ve tracked them, they are lower utilizers; I won’t speculate, I’ll just say those are the facts that we have seen and those are the individuals that have left and it has impacted our business mix change that way.
Wayne S. Deveydt
Josh, the one thing I would add is that because of this unique environment we’re in and understanding human behavior through layoffs and recessions and how that all comes about, I think that’s why we’ve said that our best estimate is that the second half of the year is about $125 million between mix shift and COBRA. So, what is hard for us to get our hands completely around is how much of that is, and we have a pretty gauge, we think COBRA is about half of that, but we do think some of that is just individuals that loss their jobs too running out and sort of getting some procedures done potentially, and we see a little bit of a utilization pattern there.
Again, at this point, we have a lot of data points that says that it appears we’re having a mix shift and we’re having some higher members, but as Angela said, that really was predominantly noticed in the last month of the quarter, but we think to ignore that in this environment again wouldn’t be prudent. So we are taking that and run rating that for the latter half of this year.
Joshua Raskin - Barclays Capital
That makes sense; so June was the high end of the 8% plus or minus 50 basis points?
Wayne S. Deveydt
Yes.
Joshua Raskin - Barclays Capital
That’s the assumed run rate for the second half?
Wayne S. Deveydt
Yes.
Operator
Our next question comes from the line of Matthew Borsch - Goldman Sachs.
Matthew Borsch - Goldman Sachs
Could you just maybe drill down a little bit in terms of what you’re seeing, price competition; I think in California you had not so recently alluded to aggressive competitor in that market, wondering if there’s any change in your view there and anything else you can give us, on maybe the Northeast.
Angela F. Braly
Matt, we’ve got the experts here; Ken and Brian. So, I am going to turn it over to them.
Ken R. Goulet
I’ll start and talk about the employer group and Brian I think will address individual and seniors. The marketplace continues to be competitive, but rational.
We see pockets of increased competition from time to time and you’ve mentioned California. We’ve identified in the past that California small group was very competitive due to a variety of items but due to a marketplace competitor.
That competitor did have significant rate increases on 07/01/09 and should help us as we move forward in one of our key states; our position should improve and we should be in a better position; the second primary competitor across California and others has just indemnified that they have missed some trends and that they’ll be pricing more rationally going forward. So, by looking our key states, we are seeing a more firming up of pricing which is one of the areas that we had run into.
Others are various pockets, there are some non-profit areas in a couple of our states, have swings of what I would say is more competitive pricing, but in general, the marketplace I feel is firming up in that the pricing is coming tighter as competitors are identifying trends similar to our own or the pricing range similar to our own.
Brian A. Sassi
For individual, we’re still seeing relatively rational pricing, although in some of the key markets, particularly California, I think Aetna recently announced that they are raising rates in several other key markets including California as well as the other Blue competitors that we have in that state just recently announced some pretty healthy rate increases too. So, I think that will help the overall competitive environment.
Matthew Borsch - Goldman Sachs
On the 2010 outlook, can you just directionally tell us if you think at this point your operating earnings excluding share repurchase will be up in 2010 or not?
Wayne S. Deveydt
I don’t want to get ahead of my board here, but I think having operating earnings be positive next year will be a very difficult challenge. I do think that as we work toward it, we would like to neutralize as much of a downslope that could be there, but again, I think especially because some of the investments we want to make, and again, I don’t want to get ahead of my board, but I would not expect operating earnings growth next year in this environment.
If the unemployment environment continues where it’s at, the COBRA that we expect to pick up in the second half of this year, and I don’t expect that to go away next year, and the mix shift that goes with that, I think coupled with the CMS headwind and marginal impression on senior will make operating earnings growth next year a significant challenge.
Angela F. Braly
That said Matt, everything we talked about today and talked about generally with respect to 2010, we were excluding the express group transaction may affect below the line of taking out those shares as well.
Operator
Our next question comes from the line of Doug Simpson - Morgan Stanley.
Doug Simpson - Morgan Stanley
Wayne, maybe to push a little bit on this; sorry to be the dead horse, but you beat in Q1 and beat in Q2, you talked about a June uptick in utilization from the healthy members in the COBRA; can you just give us a sense, if you had seen these same trends in ’07, how would you think about the second half in the year. I am just trying to gauge how much the uncertain backdrop is factoring into your thoughts on the second half.
Angela F. Braly
I am going to speak to that a little bit and I answered one of the earlier questions by saying we think given what we’re seeing about unemployment, we were very conservative, we thought in terms of overall employment and we’re looking at our Blue states in particular at a weighted average there, and what happened this year obviously is that the unemployment rate ticked up faster so that member months are gone longer and so now there is an assumption while it’s higher and we’ve raised our expectations about unemployment for the rest of the year, we’re expecting that to continue to flatten out a little bit as we go forward and not really tail off until the end of 2010. So, given just the volume we’re being thoughtful about that.
Then, we’ve had this debate about whether the economy induces this slight uptick we’ve seen in utilization, and so we think given the outlook we think it’s appropriate to be thoughtful about what that trend might be billed and what we think effectively the second flu season or the continuation of the first flu season is. As I said earlier, I really do think now is not the time for us to change our guidance.
Operator
Our next question comes from the line of Scott Fidel - Deutsche Bank Securities.
Scott Fidel - Deutsche Bank Securities
First question, maybe if you can talk about how you expect the budget deal in California will impact the MediCal and Healthy Families businesses.
Brian A. Sassi
Based on what we know today, we’re not anticipating an impact to MediCal. There will be potential impact to Healthy Families and we know that there are eligibility changes; in fact new enrolment is being capped.
So that will put downward pressure on membership as no new members come on and members lapse each month. Then, there was an additional $50 million cut that was part of the signed budget package for Healthy Families.
It is not clear yet how that’s going to manifest itself in terms of either reduced benefits, eligibility, or rates. So, I think it’s a little too soon to tell, but we’re closely monitoring the situation.
Scott Fidel - Deutsche Bank Securities
Then, I just have a followup question just on reform; maybe if you can about this contemplated new tax on insurers that is being discussed in the Senate Finance Committee and how you think that would potentially impact the pricing and margins for the industry, and then also, if the tax only focused on plans with an actual value of $25,000, what percentage of plans actually have an actuarial value of over $25,000?
Angela F. Braly
Let me try and address it. I don’t really know that we know the exact percentage of our book that would exceed that; I don’t really believe that the market will adapt to that, if the tax were approved, it would adapt and you would see benefits not exceeding whatever those thresholds might be in reality.
So, I think it really puts into question whether or not you get the yield from a tax perspective off those kinds of benefits; and generally, if we’re taxing the benefit packages, this is an initiative; all of this reform discussion is really intended to have sustainable solutions around affordability. Adding taxes onto premiums doesn’t have that impact.
Operator
Our next question comes from the line of Christine Arnold - Cowen Investments.
Christine Arnold - Cowen Investments
I have a question about the commercial MLR; if I take the $100 million in positive development and I take the federal employees out and I attribute it to your government business, I get a commercial MLR that’s up about 200 basis points year-over-year. First of all, is that in the hunt?
Angela F. Braly
Christine, first of all the $100 million is predominantly coming out of consumer.
Wayne S. Deveydt
Yes, in fact Christine, I would say it’s almost all consumer, on the $100 million; there is even less than a penny in commercial potentials. I’d say it is all consumer at this point.
So, that is not impacting the commercial directly, but directionally, you’re absolutely right. We’re elevating it, and again, the vast majority of that elevation really is related to those items we talked about in the second half of the year that would take in the cautious view on being the COBRA, the potential second flu season that could occur, and then the mix shift utilization.
Christine Arnold - Cowen Investments
Right, I put the $100 million in government assuming that kind of thing is consumer. So, the commercial MLR is up about 200 basis points year-over-year?
Ken R. Goulet
It’s slightly south of that; that’s correct Christine.
Christine Arnold - Cowen Investments
You’re expecting a 200 basis point increase in the commercial MLR year-over-year for the third quarter and fourth quarter as well?
Wayne S. Deveydt
As you know Christine, we’re not giving the quarterly guidance, but I do think we have a level of conservatism that we still believe in our balance sheet which also impacts that MLR and from an outlook perspective, we are assuming some level of medical management that we will do in the latter half; so, it’s fair to run rate that 200 basis point throughout the back half of the year, but I will tell you clearly that fourth quarter MLR will be the highest quarter for us based on our expectations right now.
Christine Arnold - Cowen Investments
I am just trying to get an understanding how you’re thinking about it; so you are thinking the 200 basis points of MLR deterioration in commercial year-over-year that you saw in the second quarter will improve because of medical management and you’re not including any benefit from any reserved releases in the second half; is that fair?
Wayne S. Deveydt
That’s correct.
Christine Arnold - Cowen Investments
How much medical management improvement are you expecting and what are you doing to achieve that?
Angela F. Braly
I appreciate you asking us what we are doing about it. I think that’s a great place to have Ken talk a little bit about products and Brian to talk a little bit of Stay Covered.
Ken, you want to talk about some of the products and medical management initiatives?
Ken R. Goulet
Christine, a couple of things. First, when you do look at MLR and I want to address just one piece of that; it’s primarily as we mentioned in the comment; it’s very heavily driven by Ohio and California and that is where the economy and the macro impacts are greater than other areas of our states.
We’re right now in California, we’re having an 11.6% unemployment rate, in Ohio, we are having an 11.1% unemployment rate; both significantly greater than the severe end of the thoughts we had going into the year. We do have a variety of what I’ll call annual benefit changes that are going into place, that went into place midyear this year, which are product driven reductions where we’ve implemented changes to our product portfolio which will change our utilization pattern such as emergency room deductibles, a number of items that were used to bring us up to speed in our book and our product portfolio that will reduce cost overall, but not be a big piece when an employer is making decisions regarding overall product need and product purchases.
We do have a lot of products coming out. Angela had mentioned what are we doing in new product releases; we also have a number of new products coming out, our Blue product which is our lower cost product across the board.
We’ve done the HMO selector, a new HMO product portfolio in California. Our Anthem Alliance which is a product we’ve rolled out in Connecticut, and several others, but I would say the primary driver is really our annual benefit changes which will have a significant impact on our MLRs moving forward.
Angela F. Braly
Christine, I want to talk about just some of the medical management initiatives specifically. We’re always looking at contracting and re-contracting and in particular we’re looking at hospital coding practices; our 360-degree healthcare management programs are really getting recognized, I would say some of the national account sales we’re seeing are a reflection of that, and those programs we think were showing their effectiveness and really getting to the right member, and then we’re looking at very specific areas; we’re looking at neonatal, spinal surgery, chronic kidney disease, end-stage renal disease; we’re focusing our utilization management on some high-cost facilities because in addition to the utilization slightly ticking up, we have seen people going to certain higher-cost facilities, and now we’re really zeroing in on that.
Our AIM radiology subsidiary is really getting some traction and we’re able to turn that technology on to cardiology and other things. So, we’ve got some very specific initiatives and then the Stay Covered thing, Brian is going to speak to it.
Brian A. Sassi
The Stay Covered project is really a cross functional initiative between commercial and consumer to try and retain those commercial members that are losing coverage and encouraging enrolment in our individual plans or our senior plans. We have an estimated about 2 million people that leave WellPoint plans involuntarily each year.
Obviously, this year has been an unusual year. So, there is a tremendous opportunity for us to retain more of these members, either our individual or senior.
So, we’ve initiated a comprehensive program where we have new messages and advertising, very targeted direct mail programs, focused dedicated websites, and broker communications to really keep people covered with WellPoint. We’ve got some key pilots going with our national accounts and a very focused effort in the state of Ohio, and then as those programs develop further, we’ll be rolling that out in some of our other key geographies.
Wayne S. Deveydt
Christine, the last thing I just want to add is just to circle back and then full circle which is, no we have not assumed any positive development at all related to the benefit expense in commercial, and we do believe we’re conservatively reserved there and two is, many of these medical management items you’ve heard about were things that we had well underway before the spike part of it I’ll call normal course of business items. So, we’re not baking in what I would call much benefit from new medical management initiatives in the second half of the year.
So, anything we do will help to try to mitigate that in some way shape or form, but just recognize those initiatives, really are difficult. Here we are getting ready to start to August; so you can’t just turn them on tomorrow.
So, as they roll out over the back half of the year you really will start getting the full run rate benefits going into the following year. So, we’re not baking in a whole lot of benefit relative to that MLR related to the new medical management initiatives.
Operator
Our next question comes from the line of Thomas Carroll - Stifel Nicolaus & Co.
Thomas Carroll - Stifel Nicolaus & Co.
Just to continue the discussion on the medical cost trend component in your comments you made; have you observed a change in provider behavior as a result of the recession that perhaps is helping to drive some of the higher trend to perhaps utilization, and you’re just making some utilization comments. We’ve had another competitor who was talking about this as being a primary reason they were pointing to higher costs.
Angela F. Braly
Tom, we’re studying that very carefully and we have seen an increase in acuity levels, some of which we attribute to the fact that the CRG reimbursement methodology changed in late 2007 and so we’re really digging deep into the coding to really understand that, and as I just said, we’re seeing the mix of facilities change slightly, so people are going to some of the higher cost facilities and we think that it’s driving some of the higher acuity as well. We’re seeing that specifically sometimes around the children’s hospitals, there tend to be a higher cost and some utilization is picking up there; and so, what we’re doing about it again is evaluating those coding issues.
Looking at acuity, we also took a cut looking at what we think are elective type procedures and where those are being done and we’re working those into our hospital negotiation strategy.
Thomas Carroll - Stifel Nicolaus & Co.
Okay, and then just as an administrative question, what is your CapEx you’re thinking about for this year?
Wayne S. Deveydt
We’re fully loaded and this would include both what we expend must be capitalized, so fully loaded is about 650 a year and that’s a combination of certain components of lights on. I expect that next year that that will continue, and again, subject to board approval, there are some investments that we will want to make going into next year, and again, I don’t want to get ahead of our board, but I do think there are some areas where we could really drive some long-term value for our shareholders in terms of 2011 and thereafter we make some of those investments.
Thomas Carroll - Stifel Nicolaus & Co.
Could you quickly run through what you’re expecting to dividend from your subsidiaries again this year?
Angela F. Braly
Yes, Wayne covered that in his remarks.
Wayne S. Deveydt
For the year we had said that we would expect an ordinary dividend of at least $2.4 billion with dividend year-to-date slightly under $900 million; so, we would expect in the second half of the year an additional $1.5 billion of ordinary dividends from subsidiaries. As you know, with the way the OTTI rules are, we’re always forced to book all the downside through the P&L but you never get the book the upside, and since December 31st, our underlying portfolio has improved by over $700 million, almost $740 million.
That apparently then increases the statutory equity of our sales which will give us an opportunity then to do some extraordinary dividends; now I hate to quote what that could be because that subject is state by state approved, but I would say that it’s safe to say that the floor on dividend for the back half of this year would be 1.5 and I would expect to see it somewhere north of that.
Operator
Our next question comes from the line of Carl McDonald - Oppenheimer & Co.
Carl McDonald - Oppenheimer & Co.
Could you update us on where things stand with respect to the CMS and the Medicare sanctions?
Brian A. Sassi
We are continuing to work with CMS; they have requested some additional information which we’re in the process of collecting and sending to them, and that will be complete within the next week or so; we’re actively preparing for participation in open enrollment and submitting our marketing materials, etc., to CMS.
Carl McDonald - Oppenheimer & Co.
Your assumption is that this will be lifted before the marketing season begins?
Brian A. Sassi
That is our working assumption, yes.
Carl McDonald - Oppenheimer & Co.
And, can you also give us some color on how the Medicaid business performed this quarter and also spiking out if the favorable development contributed to that?
Brian A. Sassi
State sponsored did contribute to the favorable development. Our state sponsored business continues to perform better than our expectations this year primarily as a result of a lot of the actions that we took earlier this year and last year.
Wayne S. Deveydt
The one thing I would say, Carl, is that I think there’s been some individuals that are seeing some higher utilization and spikes in the Medicaid, we’re not seeing it, but I also think it’s important to recognize that the states we were having those issues in the past and one of those being Connecticut, we made the decision to pull out off; so, I think when we look at our core states, as Brian mentioned, they’re performing pretty well and we put a lot of initiatives and changed the leadership there, so we think we’re seeing the benefits of those investments as well.
Brian A. Sassi
And I think in California which is our largest Medicaid state, we’ve now converted over 80%, 85% of our contracts to capitation, so that does insulate us from some of the utilization risk.
Operator
Our last question comes from the line of Ana Gupta - Sanford Bernstein Co.
Ana Gupta - Sanford Bernstein Co.
I have a couple of questions on reforms; the first one is, as a former Blue consolidator, can you provide your perspective on this regional co-op network thing that’s being proposed by Senate Finance, and followup to that is, what is your expectation on the outlook for Blue consolidation given that’s the growth lever for you?
Angela F. Braly
Yes, Ana you started off by saying we were a former Blue consolidator; we don’t think of our sales as a former Blue consolidator but as a compelling partner for future Blue consolidation as well. I think it’s unclear in terms of where Senate Finance is going to come out either on the co-op or on exchange related questions of state versus regional.
In the past, whether it was Medicaid or others where there was an approach that was regional, it’s really hard to sustain a regional approach, and it really comes down to being state based, either you look at it on a federal level or you look at it on a state level. So, we are yet to see how this regional idea is going to prove itself out or be implemented, and we would obviously favor a state based system no matter what because we think there are significant differences very locally and obviously reflect how we manage our business and the benefits we think of managing on a more local basis.
Ana Gupta - Sanford Bernstein Co.
One more followup, given your exposures concentrated in the individual and microgroup site, how are you and the industry advocating with congress around MLR caps and then the leakage potentially into a regulated exchange which might have MLR caps?
Angela F. Braly
The problem with MLR caps that we’ve seen and talked about for a long time is they really drive the wrong incentive, they actually drive the incentive to increase the medical cost rather than decrease them, and so, we think they’re not a positive contribution to the reform dialogue. We did bring solutions for the individual and the small-group market, but what we are bringing to the table is just information and data about what it means because some of these changes have a very disruptive impact in terms of transition.
You’re going to have the rating, the rules that we’re discussing now give us broad bandwidth to differentiate and we have experienced rating, and that’s going to change pretty dramatically; so, we think there are some big transition issues that people really need to think about, be aware of, understand what the potential for rate shock is, and then work on mechanisms to help mitigate that. So, we’re actively participating in that and providing data and information about what it could mean in a real world context.
Ana Gupta - Sanford Bernstein Co.
Thanks Angela.
Angela F. Braly
I think unfortunately we are not going to be able to take any more comments, but in closing I want to reiterate that we are pleased with our earnings per share so far this year and we remain confident in our guidance for the remainder of the year. We are managing through turbulent economic times and are currently taking a number of steps that will improve our future performance.
Our building a better WellPoint program will help us serve our customers more effectively and efficiently. We will continue to keep our customers first, one of our core values, and strive to excel even more at day to day executions.
As our customers win, so does our entire organization including our shareholders. We are keeping our promise to simplify the connection between health care and value for our customers and our shareholders.
I want to thank all of you for your interest in WellPoint and for participating in our call this morning. I’m going to turn it back over to the operator to provide the call replay information.
Operator
Ladies and gentlemen, this conference will be available for replay starting today, Wednesday, July 29th, at 11:00 a.m. Eastern Time and will be available through Wednesday, August 12th at midnight Eastern Time and you may access the AT&T Executive Playback Service by dialing 1-800-475-6701 for within the United States or Canada or from outside the United States or Canada please dial 320-365-3844 and then enter the access code of 977146.
That does conclude our conference for today. Thank you for your participation.
You may now disconnect.