Jul 29, 2010
Executives
Michael Kleinman - Staff Vice President of Investor Relations Brian Sassi - Executive Vice President, Chief Executive Officer of Consumer Business Unit and President of Consumer Business Unit Ken Goulet - Executive Vice President, Chief Executive Officer of Commercial Business Unit and President of Commercial Business Unit Angela Braly - Chairman, Chief Executive Officer, President and Chairman of Executive Committee Wayne Deveydt - Chief Financial Officer, Head of Investor Relations and Executive Vice President
Analysts
Joshua Raskin - Barclays Capital Justin Lake - UBS Investment Bank Carl McDonald - Citigroup Inc Scott Fidel - Deutsche Bank AG Matthew Borsch - Goldman Sachs Group Inc. Thomas Carroll - Stifel, Nicolaus & Co., Inc.
John Rex - JP Morgan Chase & Co Doug Simpson - Morgan Stanley
Operator
Ladies and gentlemen, thank you for standing by and welcome to the WellPoint Conference Call. [Operator Instructions] I would now like to turn the conference over to the company's management.
Michael 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 Chair, 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 Q&A session.
During this call, we will reference certain non-GAAP measures. A reconciliation of these non-GAAP measures to the most directly comparable measures calculated in accordance with GAAP is available in our press release and on the Investor Information page of our company website at www.wellpoint.com.
We will also 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 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 Braly
Thank you, Michael, and good morning. Today, we're pleased to report a strong second quarter of 2010, with earnings per share of $1.71 including $0.04 per share of net investment gains.
Earnings per share in the second quarter of 2009 totaled $1.43 and included $0.07 per share of net investment losses. Excluding the net investment gains and losses in each period, our adjusted EPS was $1.67 for the second quarter of 2010, which represents an increase of 11% over adjusted EPS of $1.50 in the same period of last year.
Our quarterly results exceeded our expectations, primarily due to higher than anticipated favorable reserve development and continued strong performance in our capital management areas. We're also seeing positive results in our core operations from many of the strategic initiatives we put in place over the last two years.
Based on our results through the first six months of the year, we've increased our full year 2010 EPS guidance to at least $6.30 per share, including $0.08 per share of net investment gain, partially offset by an impairment charge of $0.03 per share. Medical enrollment totaled 33.5 million members at June 30, 2010, a decline of 343,000 members or 1% from March 31, 2010, which is in line with our expectations.
Enrollment in the non-Blue business decreased by 85,000 members reflecting our exit from certain markets in our UniCare business, while the remaining decline was driven by in-group attrition in the National and Local Group businesses and included a sequential reduction of 103,000 in our BlueCard enrollment. The unemployment rate in our Blue states is down slightly from the first quarter to 10%, but we expect that it will remain elevated through at least the end of 2010.
We continue to generate solid sales, with group sales running 5% better than our 2010 plan and our group retention rates remain above 90%. While most of our business units are managing well through this difficult economy, in-group attrition remains high.
Once the employment situation begins to improve meaningfully, we expect to benefit from in-group membership growth. We also expect to continue gaining share in the national accounts marketplace due to our strong and distinct value proposition.
We found that these large, national employers are increasingly attracted to our broad and cost-effective provider network and our care management and health improvement programs. We've achieved market-leading growth in the National Account segment of approximately 300,000 net new members in 2010, and we currently anticipate further growth in 2011.
We already have several sizable wins for January 1, 2011, and we expect to finalize more in the next few months. The market is competitive again this year but has been generally rational, and we're pleased with our expectation for further growth.
Fully insured enrollment ended the second quarter slightly better than we expected at $14.1 million. As we've previously discussed, 873,000 member low-margin municipal account converted to a self-funding arrangement on April 1.
After adjusting for this conversion, our fully insured enrollment fell modestly in the quarter. While down in total, a positive data point is that small group membership grew slightly in the month of June.
This was the first month of positive membership growth for small group in over a year, and we believe it's one of several positive indicators reflecting the strength of our product offerings and suggesting that the current business environment may be improving. Results in our Local Group business are running ahead of plan so far this year and have improved significantly from a year ago.
Our state-sponsored programs are also performing better this year. We implemented a series of strategic and tactical changes over the past several quarters that have improved our results.
Membership continues to grow as more people become eligible for public programs during periods of high unemployment. State Sponsored business will continue to be a growth area in the coming years, and we'll participate in programs where we can provide long-term value for our customers while obtaining actuarially sound rates.
Last month, we were awarded a contract with state of Indiana that will enable us to continue managing both the Hoosier Healthwide Medicaid managed care program and the Healthy Indiana program. This contract builds on the award we received earlier this year for the BadgerCare plus program in Wisconsin.
We look forward to serving beneficiaries of these programs over the next several years. We also view the Senior business as a growth segment, considering the demographic change that will begin next year when the first baby boomers begin turning 65.
Nearly 40% of the baby boomers who will age into Medicare in the next five years live in one of our 14 Blue states. Accordingly, in June, we expanded our successful stay-covered member aging program across the country.
This program focuses on current members of group health plans who are approaching Medicare eligibility. These members are provided with information about their Medicare options and our participating agents or internal sales team, then work with these members to help them better understand their health coverage option upon turning 65.
This member aging program was first launched for select small groups late in 2009, and now encompasses businesses in all of our 14 Blue states. We recently submitted our 2011 Medicare Advantage bid and expect to be well-positioned for the open enrollment period.
We have been improving our service and offerings in the Medicare Advantage marketplace for more than two years now, and continue to believe that there will be strong demand for Medicare Advantage products as the overall senior market grows. Healthcare reform will gradually reduce Medicare Advantage reimbursement levels, but we believe we will be well-positioned to increase volume in this business due to the changing demographics, and we will continue to focus on the new quality base incentive payment opportunities beginning in 2012.
At the same time, we are the second largest writer of Medicare supplement policies in the nation, and a major Medicare Part D carrier. So we have a balanced portfolio of products to offer consumers as they age out of commercial healthcare plans and into the senior marketplace.
While the individual market is currently facing challenges due to the economy, selection issues and in certain markets the inability to obtain timely rate increases sufficient to cover rising medical costs, we expect that over time, appropriate rates will be granted in order to sustain this important market segment for the many Americans it will serve. This market is projected to expand by 16 million people over the next decade as a result of health care reform and creating a fundamentally sustainable marketplace will be critical.
In California, we recently submitted revised rate filings that will take effect later this year, pending approval by state regulators. These rates have an average increase of 14%, but this will not cover our costs and we currently project that we will lose money in California on our existing individual contracts this year.
While we made the decision to move forward with these revised rates given the unique circumstances of the California individual market, this situation is not sustainable over the long-term. WellPoint remains committed to serving individual members.
However, in order to continue to serve customers, a carrier must be able to receive actuarially sound rates. The introduction of the minimum medical loss ratio requirements in 2011 will require changes to the individual market business model.
While these regulations are still being developed with thoughtful deliberation by the National Association of Insurance Commissioners, we will make adjustments to our business model later this year in order to compete effectively in the changing individual marketplace. Based on our current expectations, our Individual business will likely experience margin compression in certain states next year.
However, it's important to recognize that at a consolidated level, Individual business comprises less than 6% of our membership, and this year is expected to contribute less than 5% of our operating gain. We have a mature block of Individual business that generates a comparatively high MLR already, and our size and scale generally provides for a lower administrative cost ratio because we're able to spread our fixed costs over a larger membership base.
Smaller competitors will have difficulty competing in this new environment, and we've already heard that some smaller plans have indicated that they will leave certain markets unless the regulatory environment allows for a fundamentally sustainable market. The small-group market will also be affected by healthcare reform, but we expect our small-group business to be less impacted by new MLR requirements than individual, as small-group typically run a higher MLR today.
It's our goal to make healthcare reform work for our customers and the country. This is why we've adopted multiple provisions earlier than required by law, including an extension of dependent eligibility to age 26 beginning on June 1.
Managed-care organizations will play an important role in the implementation of healthcare reform legislation, and we will continue working collaboratively with our industry partners, the healthcare delivery systems and governmental agencies as the regulations are developed. We continue to believe that in order to provide Americans with access to affordable quality healthcare, the underlying drivers of rising costs must be addressed.
We're taking a leadership role in transforming healthcare delivery and are in the midst of several discussions with provider groups across our state to change the method of provider payment to a system that rewards the value, quality and coordination of care received, more than just the volume of care administered. We recently announced our collaboration with two of California's leading physician governed medical groups to launch an accountable care organization or ACO pilot project.
An ACO is a provider led organization willing to be accountable for the full continuum of care for its patients. This model encourages physicians, hospitals and insurance companies to work together to coordinate care, improve quality and slow medical cost growth.
We believe this model holds great promise for improving quality and enhancing patient outcome. As health reform expands access to millions of Americans, the growing shortage of primary care physicians will be an increasing concern.
Primary care physicians are often the front line of prevention and care, particularly for chronic illness. So the success and sustainability of their practices are vital to the health of our members.
One of the ways we're supporting primary care is through patients that are in medical home programs, which provide incentives to primary care physicians for enhanced care coordination, improved quality, patient satisfaction and the adoption of health information technology. While most of these programs are relatively young, our Colorado program, which includes participation from Colorado Medicaid, has demonstrated significant one-year improvement on care outcome in chronic illness and medication compliance.
The key to success here is partnership. Partnership with a healthcare delivery system and with other private and public payors.
So we will continue to advance and evaluate these programs and look for additional opportunities for collaboration. Other payment innovation programs we're advancing across a number of our markets include bundle payments for many common procedures, including coronary artery bypass graft, knee and hip replacement and colonoscopy.
We're also providing our members with information on quality and cost effective sides in which services can be performed, many of which guarantee or warranty their work. One definition of quality includes doing it right the first time, and many providers under these types of bundled payment arrangements are incented to provide quality care if they're paid a flat fee and don't get paid additional amounts for readmission if complications arise.
These initiatives support our goal of providing the best healthcare value to our customers. Over the last few years, we've launched several strategic initiatives across the company in support of our healthcare value strategy and we're seeing positive results from our actions.
For example, the sale of the NextRx PBM subsidiaries to Express Scripts and the related 10-year contract are proving to be beneficial to both our customers and shareholders. As of July 1, we're approximately halfway through the migration process, having successfully migrated nearly 8 million members to the Express Scripts platform already.
The remaining members will be migrated over the balance of this year. The Express Scripts transaction has lowered overall drug cost for our members while providing a significant return of capital to our shareholders.
Total claims inventory, which was a priority performance improvement item for the company two years ago, has remained at historically low levels, and is approximately 20% lower than at year end 2007. This has contributed to a second consecutive year of up higher than anticipated favorable reserve development.
From an efficiency perspective, our auto adjudication rates are above 80%, more than 150 basis points higher than at this time last year and significantly higher than in June of 2008. Our electronic data interchange rates or the percentage of claims that we received electronically, are running at nearly 90%, up steadily from a year ago.
We're continuing to implement our Building a Better WellPoint program and cost savings from these efforts are ahead of our plants so far this year. We're also executing on our strategic information technology initiative and are in the process of retiring an additional two legacy claims systems this year.
And while we're executing with greater administrative efficiency, I'm pleased to report that our customer service results have simultaneously improved. In the first part of 2010, WellPoint achieved its strongest results ever on a key measure of success, the member touch point measure or MTM scores, reported as part of the Blue Cross and Blue Shield Association service performance metrics.
The MTM scores help monitor how well we're performing at the activities that touch our members each and everyday, such as enrollment and billing, claims processing and member and provider services. These results are a testament to the process improvements we've implemented across the company and the hard work and dedication of our associates who serve our customers.
In summary, we're performing well and expect a good 2010. Membership is in line with the expectations we had coming into the year, our financial results are meaningfully improved in most of our businesses and we've raised our full year EPS outlook.
We foresee long-term growth opportunities for WellPoint and for our shareholders. And we are making investments and adjusting our business strategy to enhance our competitive advantages and prepare us for continued success in the changing environment of healthcare reform.
We'll continue to be engaged as the regulations for healthcare reform are developed and finalized and we'll work to make the implementation as successful as possible. And most importantly, we'll remain intensely focused on ways to effectively lower the healthcare cost trends our members are experiencing, while improving the quality of care they receive.
When we take care of our customers, we take care of our shareholders. And now, I'll turn the call over to Wayne Deveydt to discuss our second quarter results and current guidance in detail.
Wayne Deveydt
Thank you, Angela, and good morning. Premium income was $13.3 billion in the quarter, a decrease of $866 million or 6% from the second quarter of 2009.
Approximately $550 million of this decline related to the conversion of the large municipal account to a self-funded arrangement effective April 1 of 2010. The remaining reduction was attributable to the transfer of UniCare business in Texas and Illinois, and lower fully insured membership resulting from continued high unemployment in overall economic conditions.
Administrative fees were $949 million in the second quarter, down $28 million or 3% from the same period of last year due primarily to reduction in certain PBM related revenues earned in 2009 and lower revenue in the National Government Services business. These declines offset an increase in our commercial ASO fee revenue.
Other revenue, which historically, consisted almost entirely of revenue associated with the sale of mail-order drug by the NextRx PBM declined by $147 million from the second quarter of last year reflecting the sale of NextRx in December 2009. The benefit expense ratio for the second quarter of 2010 was 82.9%, a decline of 100 basis points from second quarter of 2009.
The decline was driven by the Local Group business and over half the decline resulted from the large municipal account conversion. This account historically maintained a benefit expense ratio higher than our company average.
The decline in the Local Group benefit expense ratio was partially offset by an increase in the Individual business due to the delay in implementing rate increases in California. In the second quarter of 2010, we recognize an estimated $100 million of higher than anticipated favorable prior year reserve development.
This is equivalent to the estimated $100 million of higher than anticipated reserve development that was recognized in the second quarter of 2009. Therefore, the comparison to the prior year quarter's benefit expense ratio was not impacted by changes in the net favorable reserve development.
We now expect that our benefit expense ratio will be approximately 83.9% for the full year of 2010. The ratio is projected to increase during the second half of 2010, due in part to the seasonality of our commercial and individual product design.
We believe the seasonality of these businesses will be even more pronounced this year due to cost related to health care reform implementation including the extension of dependent coverage to age 26. The individual benefit expense ratio will also rise as a result of the California rate delay.
Additionally, while we had higher than expected favorable reserve development in the second quarter, our guidance assumes that we do not have additional net favorable reserve releases during the second half of the year. We continue to price our commercial business so that expected premium yield exceed total cost trends where total cost trend includes medical cost and selling, general and administrative expense.
For full year 2010, we continue to project that the underlying local group medical cost trend will be in the range of 8% plus or minus 50 basis points, and we currently expect it to be at the lower end of this range. Medical cost trend continues to be driven predominantly by unit cost increases.
However, utilization remains a significant contributor to our reported trends due to influences like H1N1 flu and increased COBRA membership that are still impacting our experienced period which encompasses the rolling 12-month ended June 30, 2010 and therefore includes the second half of 2009 when flu costs run usually high. In patient hospital trend is in the low double-digit range and is approximately 80% unit cost driven and 20% utilization driven.
We understand that current unit cost trends are not sustainable especially for hospital services which account for a significant portion of healthcare spending. In all our states, we're working to lower hospital cost trends as we negotiate with hospitals and health systems.
We have had success with many health systems we've negotiated with this year agreeing to moderate unit price increases as we work together to address the cost pressures faced by employers and consumers. A handful of hospitals still do not comprehend this pressure and we will make the tough decision by altering our network where necessary.
Outpatient trend is in the low double-digit range and is 60% cost driven and 40% utilization driven. Outpatient care is the fastest-growing component of the U.S.
healthcare system, part of which is due to changing medical technology and expansion of outpatient medical and surgical facilities. This results in a continued shift of certain procedures from the inpatient to the outpatient setting.
Angela discussed some of our new reimbursement methods designed to slow the increase in outpatient trip. Physician services trend is in the mid-single-digit range and is 75% utilization driven and 25% cost driven.
Increases in physician services were driven by increased utilization in late 2009 related to the H1N1 flu and contracting changes. As provider fee schedules are adjusted, we are enhancing fee-for-service payment methods to better align reimbursement with value.
For example, we are paying increased fees for vaccines in many markets, while simultaneously negotiating more aggressive fees for the technical component of advanced imaging services in order to more closely reflect the cost of operations. Pharmacy trend is in the high single-digit range and is 70% unit cost related and 30% utilization driven.
Increases in cost per prescription are being impacted by recent inflation in wholesale drug pricing. We are utilizing comparative effective research or CER evaluation criteria to help determine optimal health outcomes for our members.
Our evaluation criteria have become a model for the managed care industry. One of the ways WellPoint has put CER to use is in conducting comparisons among members using drugs to treat osteoporosis.
In comparing three different medications, we found that members taking one of the drugs were less likely to adhere to the required maintenance schedule, likely explaining higher bone fracture rates for that drug. By keeping this drug at a higher tier and encouraging members to first try another medication on a more economical tier, we anticipate that we will help our members reduce fracture rates and increase their quality of life while saving them money due to lower out-of-pocket expenses.
Moving now to selling, general and administrative expenses or SG&A, the SG&A ratio was 15.3% in the second quarter of 2010, up 90 basis points from the second quarter of 2009. The increase reflected lower operating revenue, partially offset by a reduction in operating expenses.
Total SG&A expense in the second quarter of 2010 was 1% lower than in the 2Q of '09. We believe there continues to be opportunities to reduce our SG&A cost in the future and we believe doing so will be critical in the health reform environment.
Turning to our reportable segments. Commercial operating revenue was $8.5 billion in the second quarter of 2010, an $851 million or 9% reduction from 2Q of '09.
This was driven by the municipal account conversion, as well as fully insured membership declined due to the UniCare member transition and the economy. Operating gain was $746 million in the second quarter of 2010, an increase of $163 million or 28% from the prior year quarter.
The increase was driven by operating improvements in the Local Group business and included an estimated $40 million of higher than anticipated favorable reserve development in the current year quarter. Our Consumer segment operating revenue was just under $4 billion in the second quarter of 2010, declining by $99 million or 2% from 2Q of '09.
This was due to the loss of Medicare Part D auto-assign membership, lower individual enrollment and a change in the providers of pharmacy benefits for the Indiana Medicaid program in 2010, partially offset by growth in the Medicare Advantage program. Operating gain for the Consumer business segment was $301 million in the second quarter of 2010, a decrease of $81 million or 21% compared with the second quarter of last year.
The decline in operating gain was driven primarily by lower performance in Individual as a result of the rate delay in California and also reflected a decline in Medicare Advantage results due primarily due to reduction in Federal reimbursement rates for 2010. We recognized an estimated $60 million of higher than anticipated favorable reserve development in the Consumer segment during the second quarter of 2010.
While we recognized approximately $100 million of higher than anticipated favorable development in the second quarter of last year. Operating gain in the Other segment totaled $11 million for the second quarter of 2010.
This represented a decline of $112 million from the second quarter of 2009, and was due to the sale of NextRx. Net investment income totaled $202 million in the second quarter, down $3 million or 2% from the second quarter of '09 due to lower short-term yields in the second quarter of 2010, partially offset by higher investment income balances.
Interest expense was $100 million, down $17 million or 14% predominantly due to lower debt balances and lower short-term rates. In the second quarter, we recognized net investment gains of $30 million pretax, consisting of net realized gains from the sale of securities totaling approximately $36 million, partially offset by approximately $6 million of other than temporary impairments.
As of June 30, 2010, the portfolio's net unrealized gain position was $807 million, consisting of net unrealized gains on fixed maturity and equity securities totaling $671 million and $136 million, respectively. Medical claims payable totaled $5.1 billion as of June 30, 2010, a decrease of $370 million or 7% from December 31, 2009.
Approximately $217 million of the decline related to the municipal account conversion in the second quarter. Included in our press release is a reconciliation and roll forward of the medical claims payable balance.
This disclosure is comparable to the reconciliation provided in our fourth quarter 2009 press release. We report prior year redundancies in order to demonstrate the adequacy of prior year reserves.
Medical claims reserves established at December 31, 2009 continued to develop favorably. For the six-month ended June 30, 2010, we had significant positive prior year reserve development of $668 million, of this amount we estimate that approximately $100 million does not reestablish in our June 30, 2010 balance sheet.
We continue to believe our balance sheet is conservatively stated, and it is possible that additional reserves could be released during the second half of 2010. However, as I stated earlier, this potential has not been reflected in our current financial guidance and if it does materialize, we will separately identify it for the investment community like we've done today.
As of June 30, 2010, days in claims payable was 42.1 days, a decrease of 1.3 days from 43.4 days at March 31, 2010. DCP declined primarily due to the prior period reserve development in the second quarter.
The remaining decline related to the timing of pharmacy claim payments and a seasonal decrease in claim payment cycle times, partially offset by the impact of the large municipal account conversion. Turning now to cash flow and capital deployment.
For the year-to-date period into June 30, 2010, we reported a net cash outflow from operations of $67 million, primarily driven by the $1.2 billion of tax payments made during the first quarter related to the sale of NextRx. Operating cash flow totaled $256 million for the second quarter of 2010, down from $378 million in second quarter of last year due to higher income tax payments in the current year.
Please also recall that the second quarter is traditionally a very low cash flow period for WellPoint as we make two estimated federal income tax payments in the quarter. Importantly though, operating cash flow results are favorable to our plan for the first half of 2010.
We've increased our outlook for the full year to $1.2 billion. We utilized our capital to invest in our businesses and enhance our returns for our shareholders.
Following the sale of our NextRx subsidiaries, we repurchased nearly $50 million shares of our common stock during the first two quarters of 2010 or over 11% of the shares we had outstanding at 12/31/'09 for approximately $2.9 billion. As of June 30, 2010, we had approximately $1 billion of board approved repurchase authorization remaining.
As of June 30, 2010, we had approximately $2.1 billion of cash and investments at the parent company and available for general corporate use. We expect to receive approximately $1.8 billion in additional ordinary dividends from our subsidiaries during the second half of 2010.
We intend to utilize $1 billion for share repurchases subject to market and industry condition and we expect all other items to combine for a net use of $100 million of parent cash in the second half of the year. This would leave an estimated $2.8 billion at our parent company as of 12/31/2010.
Our insurance subsidiaries remain well capitalized and highly rated, with statutory capital levels $6.6 billion above state requirements and $3.7 billion above Blue Cross Blue Shield requirements as of June 30, 2010. This provides our customers security that WellPoint's companies will be able to pay future claims even under adverse circumstances Our debt-to-capital ratio ended June at 26.4%, up slightly from 25.5% at March 31, 2010, but still at the other lower end of our targeted range.
So we have significant financial flexibility which we value in light of the current economy and the changing health benefits market place. In terms of our updated outlook for 2010, we have raised our full year guidance for earnings per share and operating cash flow based our strong year-to-date results, specifically, we now expect net income to be at least $6.30 per share which includes $0.08 per share of net investment gains from the first six-month of 2010, partially offset by $0.03 per share impairment charge recorded the first quarter.
This outlook does not include any investment gains or losses or impairment charges other than those recorded through the first half of 2010. It also is subject to our ability to secure and maintain sufficient premium rates.
We continue to expect that year end medical enrollment will be approximately 33.1 million, consisting of 19.5 million self-funded members and 13.6 million fully insured members. Operating revenue is now expected to be approximately $58 billion.
The benefit expense ratio is now expected to be approximately 83.9%. The SG&A expense ratio is now expected to be approximately 14.8%.
Operating cash flow is now expected to total approximately $1.2 billion and this includes the unfavorable impact of the $1.2 billion of first quarter tax payments for NextRx. And our diluted share count is now expected to be approximately 421 million shares for the full year.
Also, while it is too early to talk in detail about our 2011 guidance, I will touch briefly on some of the more significant EPS headwinds and tailwinds that we are evaluating as we prepare our business plans. The most significant headwind is the minimum MLR requirements, components of which are still being formulated.
The new requirements will likely result in margin compression some of our individual and some small-group states. We have also recognized an estimated $100 million of higher than anticipated favorable reserve development this year which we do not expect to recur in 2011.
And state-sponsored has been a solid performer this year. However, federal management provisions are scheduled to decline next year and we will be incurring startup expenses associated with our new contract awards.
We are currently viewing the economy as a net mutual impact for next year as unemployment is essentially leveled off. If employment begins to pick up that would likely benefit our results.
In terms of tailwinds for next year, as Angela noted, the marketplace must be fundamentally sustainable. We are assuming that we'll be able to obtain sufficient premium rates to cover our cost trends in the Commercial and any other markets which would drive positive operating leverage.
In the senior market, while federal reimbursement rates will increase only slightly for 2011, we currently believe there's an opportunity to increase membership given the changes taking place in that market. And we also anticipate that our diluted share count will be lower in 2011, given the repurchase activity that's taking place this year.
Please keep in mind that this is a preliminary look at some of the major drivers, both positive and negative, for 2011. We are pleased with our performance so far this year, and are optimistic about our future growth prospects.
I will now turn the conference call back over to Angela to lead the question-and-answer session.
Angela Braly
Operator, please open the queue for questions.
Operator
[Operator Instructions] Your first question comes from the line of Justin Lake from UBS.
Justin Lake - UBS Investment Bank
First question on the impact of reform cost. We've seen in the -- there's a number of benefits out there that are being mandated by the government through reform.
I'm just curious as to your estimate of what you think the impact's going to be there in -- as you go into the fourth quarter specifically and then the 2011 from a cost trend and pricing standpoint.
Angela Braly
Clearly, we are working on implementation of healthcare reform and are doing -- deep into the work around pricing for the new products and for 2011. In terms of being more specific though in terms of the range and the impact, we're hesitant to do that for obvious reasons, and we don't want to affect the marketplace in ways that are not going to benefit our members.
So I'm not sure that we can give much more detail in terms of pricing trends right now.
Wayne Deveydt
A couple of things though to give you at least some -- maybe some direction, I think as Angela said, until we get final clarity on some of the rules and regulations, this will be more directional than anything. But I think it's important to recognize that when we look at the commercial book and we consider the age in the 26 lifetime limits going away and preventive care so when you look at those components, we think that will have a low single-digit impact on pricing for next year.
When you look at it relative to the fourth quarter, it's lower than that, primarily because of how the rules are actually implemented, meaning that while they go effect in the fourth quarter, many of those do not become effective until the re-enrollment periods. So if you think about the age in the 26 unless you were to turn within that age group in the fourth quarter, you won't be able to enroll for it until the next open enrollment period.
The other thing to recognize is that with our commercial book, we generally have a more robust product design. So we generally offer preventive care in a lot of our product designs and so to the extent that we offer that already, we will have less of an impact versus say other competitors that may have had a more skinny-down version of a product that did not have preventive care.
So from our perspective, we do not see as much of an impact in the fourth quarter as we do for next year but we think in pricing you're probably looking at low single-digit impact on pricing for next year.
Angela Braly
And we have to keep in mind to, Justin, that every customer is coming from a different place and their benefits are different. So when you give these kind of norms, it all depends on where their benefits are and if they hit aging increments and other things.
Justin Lake - UBS Investment Bank
And then just in terms of the guidance change, it appears the $0.30 increase there it appears that was basically a function of the investment gains plus a lower share count and the reserve releases. I'm just curious as you think of the fundamentals, as you -- going into the back half of the year, can you give us an idea of how you see that playing out as far as the continued potential for the declines in cost trends and the jumping off point for 2011, how we should think of that?
Wayne Deveydt
Justin, I would say that when you look at the change in guidance, it is due to those components that they were reserve development and better performance below the line. I would say the core operations look very solid at this point, which is one of the reasons we raised our cash flow guidance for the year.
We are taking a cautious and conservative view for the second half of the year as we wait to see some of the impacts of health reform. We believe we could probably bake that into our guidance.
But right now, I would say underlying trends look good. And as it relates to next year, that's really going to vary based on how the final MLR rules are defined at this point.
I think in some states we may do a little better. Some a little bit worse.
So it's really hard to say at this point until we get more clarity on the rules. But overall trends really have stabilized and in many areas have come down.
Angela Braly
And Justin, you were talking about the last six months of this year, we don't put into the guidance prospectively reserve releases and we never have. And also as we look at trends, as we said we are experiencing towards the lower end of the range that we've provided around overall trend.
And as you'll remember, the last quarter in particular, by the last six months of the year, more and more each year now reflect more seasonality reflecting kind of the nature of our product designs and as the deductibles wear off, we see kind of more seasonality in the third and fourth quarter. But all of that is planned for in our guidance.
Operator
Your next question comes from the line of Josh Raskin from Barclays Capital.
Joshua Raskin - Barclays Capital
Angela, you mentioned you would need to make changes to your individual product and the business model there. I'm assuming that includes distribution cost.
Could you talk a little bit about what you meant when you said fundamental changes to that business model?
Angela Braly
Yes, I will, Josh. Brian's here though and he could probably speak in more detail about that.
Brian?
Brian Sassi
What Angela was referring to is we're taking a look at basically all aspects including, distributions costs, G&A expenses, obviously, we're working on our product changes to be compliant post 9/23. Not in a position to kind of get ahead of our announcements but one of the components is distribution costs.
And so we're looking at that across the board, and we'll be announcing potential changes in some markets later this year to take effect next year. It's not as simple as announcing one thing across the board, because we pay both our internal distribution and external distribution differently in each of our states.
And so, we're looking to primarily get alignments, but again, we've been talking with our distribution channel across the country, getting their input. But not in a position to kind of release the details, particularly since a lot of the regulations surrounding MLR are still outstanding.
Joshua Raskin - Barclays Capital
Logistically, Brian, when would you need to make announcements to your distribution partners in order to have something set up for January 1?
Brian Sassi
Typically, all of our contracts have a minimum of 30 day. We would at least provide that to our distribution partners.
Again, a lot of this is predicated on when we're going to get the MLR final regs.
Joshua Raskin - Barclays Capital
Just a quick follow up on the drug trends with Express Scripts. I think, Wayne, you had given Rx coming in at high single digits.
Could you maybe give us a sense on the procurement side the cost of buying drugs with Express? What sort of savings do you think you are seeing relative to where WellPoint PBM went?
Wayne Deveydt
Yes, Josh. This probably won't answer your question clearly.
It's a little more complicated than just a percentage decrease. But what I can tell you is that on every product line that we had, whether we were looking at generic drug distribution, specialty drug distribution, retail distribution, mail-order versus non-mail there was a discount that could range from a few percentage points to say mid-single digits across the board.
Some cases, it was even higher, but those were on less frequently used drugs. What's interesting though is because overall utilization is down, so we are seeing the savings we expected by drug, but the volume isn't there because of overall utilization being down.
So when we're looking at it on a percentage basis though, I don't think it's unreasonable to assume that you're saving mid-single digit range in general relative to previous contracted in terms.
Angela Braly
Let me also add to that. There was a strategic value -- many strategic elements of that transaction but as we are migrating this membership on to the Express Scripts' system, part of the value we get is that they have some capabilities that deal with mail-order, getting the member to lower-cost drugs, working with the member on compliance in terms of their medication regimen.
So we're beginning to see the benefits of that as well, and will so even more as the rest of that membership is migrated over to their platform.
Operator
Your next question comes from the line of John Rex from JP Morgan.
John Rex - JP Morgan Chase & Co
Just a follow on to your commentary on reform, impact reform provisions, that go alive into this year and impacts, you've grouped up kind of three of the important ones and the other one I was curious about your view on was the impact of pre-existing condition clause for children and how you size that. Were you including that in your commentary of kind of the young adults lifetime limits and preventative care or was that separate?
Angela Braly
John, I think we need to start thinking about as we get into the reform discussion a couple of things. One, we're going to have this body of membership which is grandfathered.
And for the grandfathered membership there are certain changes that went into effect, for healthcare reform will go into effect this fall, on the grandfathered books, but those were fairly minimal. So they're going to be kind of one body of membership.
Then we have new products that are being -- will be filed and issued going forward that would be kind of the non-grandfathered healthcare reform provision. And those, obviously, you'll have a different experience and a different pricing base and as we look at increases over time, those will reflect the nature of the benefit.
In terms of some of the more explicit provisions around healthcare reform that are coming forward, including additional regulation that are coming forward, we didn't really speak to that specifically. A lot of it still has to be defined and there still is even some more moving parts around the child's only policy or the pre-ex for kids.
There's some discussion about additional regulation around that, and so we're still evaluating that guidance. It's difficult for us to speculate on what that means in terms of the impact overall, and we've got to asses what our options are around that business as well.
Wayne Deveydt
And John, for those reasons, the numbers I spoke about previously were only the Local Group business. So until we get more clarity on that and what profit designs we have and how we may change those and some more clarity, we are not including anything for the guarantee that she did.
John Rex - JP Morgan Chase & Co
A number of plans have spoken to this, the pre-existing clause, potentially in an individual book being worth a few hundred basis points of cost pressure on the adverse selection risk. Would you agree with that directionally?
Wayne Deveydt
I think, directionally, yes. Yes, it's going to have an impact.
But again we really want to get a little more feedback on the regulations and whether or not -- late last night the provision was added that there may be an open enrollment period. And so we really want to get more clarity around that and what that would impact.
But yes, John, I'd say directionally, that's reasonable.
John Rex - JP Morgan Chase & Co
I'm glad you brought that up because I'm referring specifically to that, so that reg that came up on the HHS site late last night where now there'll be open enrollment period. How important is that in terms of mitigating what could have been quite a bit of pressure there?
Angela Braly
I think that is important. I think there's a lot of good work being done right now in evaluating what the consequences of some of these provisions are and really understanding what it means in terms of the sustainability of these products in these markets over time.
So we appreciate the guidance there and we need to study it a little bit and study what our options are relative to that.
John Rex - JP Morgan Chase & Co
With that, I guess with an open enrollment period though, would that essentially mostly mitigate what could have been a few hundred basis points of pressure in your view when you kind of think about how that impacts the book?
Angela Braly
Not necessarily, John. So we're going to evaluate that carefully and think about what actions we need to take with respect to that.
John Rex - JP Morgan Chase & Co
Just your view on cost in general. There's a lot of commentary kind of utilization being slack in the cube.
Could you just comment here as you think about your books of business, commercial and the government books, are you seeing different trends in the utilization there or are seeing kind of weaker utilization trends across all books regardless of the class?
Angela Braly
Let me say this because I want to clarify when I was -- it was responding I think to Justin's comment earlier. We're looking at overall trend and we were at eight, plus or minus 50.
We are trending in the lower end of that range. But let me turn it over to Ken, since he can speak to some of the commercial experience that we're having and he and Wayne might comment more.
Ken Goulet
John, this is Ken. We have seen favorable trends as we indicated and for a variety of different reasons but the trends Brian and I both have seen lower trends in general.
There may be spiked out in different areas of the business slightly but in general, there is a lower utilization on both books.
Wayne Deveydt
And John, the one thing I would add is that beyond just the state-sponsored, that Brian is seeing positive in as well, when we look at our FEP business one of the reasons for the change in our revenue guidance as you know is FEP is essentially a cost-plus program and about 40% of that change in the guidance is due to us having overall lower claims experience on FEP which, of course, translates in lower revenue as well.
Brian Sassi
And this is Brian. I agree with what Ken said across most of our business.
We are seeing in some of our regions an uptick in individual utilization and trends.
Operator
Your next question comes from the line of Doug Simpson from Morgan Stanley.
Doug Simpson - Morgan Stanley
Wayne, could just talk to the $2.8 billion I think was the number you threw out for cash at year end, is that the sort of working capital you plan to hold for some period or is that just sort of where you see yourself winding up? If you could also connect the dots to the debt to total cap down at 26%, how much dry powder do you need to keep around and just maybe give us a sense for how that may play out?
Wayne Deveydt
Yes, Doug, just want to remind all those on the call that we have approximately $1 billion of debt coming due in January of 2011. So when we look at our working capital, short of us refinancing, and I would fully anticipate that we would be able to refinance the debt.
The markets are favorable at this point. But subject to that ability, no, we would not need to maintain $2.8 billion for working capital purposes.
We do want to have an opportunity though first to refinance that debt though before we would discuss with our board opportunities on how to deploy that additional excess capital at this point. But ultimately, we like to keep enough cash on hand to cover at least 12 months of interest and principal payment.
And outside of that, we have very few requirements at all at the parent level. So we would anticipate meeting with our board later this year to discuss those capital levels.
Doug Simpson - Morgan Stanley
And then maybe if you could just talk to the end group attrition. Is there any data you can help us with on the characteristics of the lives you're losing as a result of that?
Just thinking about the incremental margin and the negative leverage carry from that. If we got 100 basis point lift in employment, how would that impact the business and the risk pool overall?
Brian Sassi
We've experienced attrition since the recession began on both our -- on really all of our books of business but it's been predominantly in the small micro group market. Almost a third of the business that we lose is not going to a competitor, but is going through attrition of dropping coverages or transitioning to individual coverages.
And the larger group business or multistate national account, it is attributed to layoffs, as well as to off-sourcing. What we saw this month in Small Group was we did have growth for the month overall in membership, and that was because attrition was down.
We have been seeing it go down in each of our books of business, but it is still a fairly large negative, whereas 18 months ago, it was a positive month-over-month. So we anticipate as the business turns, we'll see both Small Group and National with increases and it's the Small Group that'll impact our margin.
Angela Braly
In terms of experience too, I think you have to keep in mind, we've had higher than kind of a normal run rate at COBRA as a result of unemployment and some of that is beginning to essentially age off because it was subsidized for a period of time. So we're getting to the point where we're seeing that experience from the COBRA membership, and as we go through the rest of the year, some of that we anticipate will be dropping off.
Operator
Your next question comes from the line of Matthew Borsch from Goldman Sachs.
Matthew Borsch - Goldman Sachs Group Inc.
Did you indicate directionally whether you think operating earnings will be up or not in 2011 or is it too early at this point?
Angela Braly
Too early at this point to really comment on 2011, Matt. So you didn't miss it.
Matthew Borsch - Goldman Sachs Group Inc.
As you look at the grandfathering by your employer groups. Do you have any sense for how broadly employers are going to try to hold onto grandfathered status and where that might make it difficult for them to make the necessary benefit design changes to offset cost trend pressure?
Are you starting to have some fix on that at least for 2011?
Angela Braly
Yes, Matt, I'm going to let Ken answer that. I have to tell you from an operational point of view and implementation point of view, we are assisting our groups to either maintain their grandfathering or move forward to change their benefits as they might desire knowingly so that they know whether or not they're going to impact the grandfathering.
So Ken, you want to talk about how that's being received?
Ken Goulet
We've been working hard. We made the decision.
Of course, we could have saved operational dollars by not allowing grandfathering across-the-board. We want to leave that options open for our employer groups and we've been working with them and educating our brokers and groups in doing that.
We've done a lot of primary market research. There's still some confusion about the bill and how it will impact but we have seen a lot of questions and individual companies making choices about the benefits they have.
Of course, we have some flexibility on the buy down benefits and self-stayed grandfather. That was important in the provisions that were being offered.
I can't give a percentage yet, but we felt it was extremely important to keep the books open for two reasons. One, to give the flexibility to the groups.
And secondly, for the groups that are deciding to remain under grandfathered programs to be -- are better risk groups. It'll preserve the better risk pools for those individuals and let them keep their rates and benefits at the levels they're more accustomed to.
Operator
Your next question comes from the line of Scott Fidel from Deutsche Bank.
Scott Fidel - Deutsche Bank AG
We've seen some reports recently of some of your peers talking about considering expanding or diversifying their intermarkets outside of health benefits just given some of the expectations for reform pressure and just interested in your thoughts around that in terms of the product and market mix and whether you would consider expanding into certain markets outside of sort of the core health benefits markets.
Angela Braly
We do have an important element of what we call our specialty business. So our dental business is growing rapidly, vision, life disability, other kind of ancillary product offerings.
We are evaluating all the strategic options as well as geography. We have operations and some other opportunities to expand more globally.
So we are considering those issues. We, first and foremost, though, are very focused on serving and satisfying our members and taking care of them and there's a lot of additional value that they could receive from us through expanding the portfolio of offerings that we have available for them.
Scott Fidel - Deutsche Bank AG
And Angela, would that include looking at expanding into new products and markets or really just expanding some of the specialty and other offerings that you already currently offer?
Angela Braly
I'd say, we talk about the core business as saying the medical insurance business and the non-core business being specialty and other opportunities. So we're expanding our view of non-core growth opportunities as well, and there are many ways in which, synergistic ways, in which our customers would benefit by that expanded relationship.
Operator
Your next question comes from the line of Carl McDonald from Citigroup.
Carl McDonald - Citigroup Inc
You've had more direct experience with the difficulty raising rates than probably anybody and it certainly makes sense that you ultimately get a rate increase in places like California and Maine where you're not making money right now. But you also have a lot of individual and small-group markets where you do very well now.
So why shouldn't we be worried about pricing pressure in those markets next year?
Angela Braly
I'll let Brian talk a little bit to the experience that we're having across the states. As we commented earlier in the remarks, it's really important to think about this from a long-term perspective and we need a sustainable marketplace.
And so I think as these issues continue to be evaluated, people understand the actuarial principles, the dynamics of what the rate need to reflect and I think that's going to find an equilibrium over time.
Brian Sassi
Carl, I'm sure you're well aware, reg-review process has been in place in most of our geographies. So this is kind of a normal course of doing business.
I think one of the things that we've learned is that becoming as transparent as possible with the regulators in terms of our rates, what's needed with our rates, following the additional scrutiny in California, we've had a number of inquires across our states, a number have reaffirmed our rates. Others have posted additional questions and we continue to work with the regulators.
We anticipate that into 2011, some states are going to look closer, and I think other states have been pleased with our level of rate development and the levels of transparency which we only expect to continue and to get better.
Angela Braly
Operator, I think we have time for one more call. Final question.
Angela Braly
Your final question comes from the line of Tom Carroll from Stifel Nicolaus.
Thomas Carroll - Stifel, Nicolaus & Co., Inc.
Angela, you indicated that less than 5% of your operating gain comes from your individual book. What is the corresponding number for Small Group?
Angela Braly
Wayne, you want to speak to that? We don't typically...
Wayne Deveydt
Yes, we don't typically break out by segment. The one thing I would say, Tom, is obviously, it's more than what our Individual is.
I would highlight though that on the Small Group business, the exposure from the MLR is not as significant at all compared to the Individual. Most of our Small Group already runs a higher MLR.
And so I think the bigger issue we wanted to highlight for shareholders is where the concerns might be around Individual but the exposure isn't what many believe it is and we believe we'll be able to manage it.
Thomas Carroll - Stifel, Nicolaus & Co., Inc.
So as a follow-up on the Small Group, would you suggest that a quarter of your Small Group business perhaps is going to feel some pressure or is it more like a half and some magnitude of the actual size of the Small Group book that perhaps is going to get pressured?
Wayne Deveydt
It's difficult to answer until we get the final rules around the MLR. I would love to give you more clarity but until we can get further clarity on it, is really a difficult question be able to answer.
Angela Braly
And let me just say the small group market is one where we have lots of expertise and in this economy and with the challenges that small groups have, they're really looking carefully at their benefits and we're working with them on whether they should be grandfathered or have other benefit designs. So we're really partnering with them and working together to make sure that they can have benefits that are affordable.
I'm going to have to apologize for others who were in the queue and didn't get to ask their questions. We're going to be respectful of the fact that many of you guys might have to get off pretty quickly and I want to thank you all for the questions that you have provided us.
In closing, I want to reiterate that we are performing well in 2010, and we do remain confident in the future. Our underlying business is doing well, and we benefited in the quarter from certain non-run rate items that have had a favorable impact on our quarterly results.
We are taking a leadership role in our industry and making changes to our business model to enhance the quality of care, while holding down increases in future medical costs and operating expenses in order to further enhance our strong value proposition. We believe we're well-positioned to drive increased value for our current and our future customers and our shareholders.
I want to thank everybody for participating on our call this morning, and we're looking forward to speaking with you on our third quarter earnings call that we've currently scheduled for November 3, 2010. Operator, please provide the call replay instructions.
Operator
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