Molina Healthcare Inc

Good day and welcome to the Molina Healthcare second quarter 2022 earnings conference call. All participants will be in a listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Joe Grotreski, Senior Vice President of Investor Relations. Please go ahead.

Good morning, and welcome to Molina Healthcare's second quarter 2022 earnings call. Joining me today are Molina's President and CEO, Joe Zabruski, and our CFO, Mark Kahn. A press release announcing our second quarter earnings was distributed after the market closed yesterday and is available on our investor relations website. Shortly after the conclusion of this call, a replay will be available for 30 days. The numbers to access the replay are in the earnings release. For those who listened to the rebroadcast of this presentation, we remind you that the remarks made are as of today, Thursday, July 28, 2022, and have not been updated subsequent to the initial earnings call. In this call, we will refer to certain non-GAAP measures. A reconciliation of these measures with the most directly comparable GAAP measures can be found in our second quarter 2022 press release. During our call, we will be making certain forward-looking statements, including but not limited to statements regarding our 2022 guidance, our 2023 outlook, our growth strategy and expected growth, our RFP submissions, the COVID-19 pandemic, our acquisitions, our future margins and embedded earnings power, and our long-term outlook. Listeners are cautioned that all of our forward-looking statements are subject to certain risks and uncertainties that can cause our actual results to differ materially from our current expectations. We advise listeners to review the risk factors discussed in our Form 10-K Annual Report filed with the SEC, as well as the risk factors listed in our Form 10-Q and Form 8-K filings with the SEC. After the completion of our prepared remarks, we will open the call to take your questions. I will now turn the call over to Chief Executive Officer Joe Zabrowski. Joe?

Thank you, Joe, and good morning. Today, we will provide updates on several topics. Our financial results for the second quarter of 2022, our full year 2022 guidance in the context of our second quarter results, our growth initiatives and the reaffirmation of our strategy for sustaining profitable growth, and an early outlook on 2023 premium revenue and earnings growth. Let me start with the second quarter highlights. Last night, we reported adjusted earnings per diluted share of $4.55 for the second quarter, with adjusted net income of $266 million on $7.8 billion of premium revenue. Second quarter adjusted earnings were decreased by 44 cents per share for a true up to our 2021 final marketplace risk adjustment transfer payments. Excluding this out of period item, our adjusted earnings per share was $4.99. Our 88.1% total company MCR in the second quarter demonstrates strong operating performance, even as we navigate prolonged pandemic-related challenges. As Mark will describe later, the reported MCR included increases related to the 2021 Marketplace Risk Adjustment True-Up and the accounting impact of a revenue pass-through. As such, our underlying pure period MCR was 87.2 percent. Similarly, our reported pre-tax margin of 4.4% increases to 5%, which is at the top end of our long-term target range. For the quarter, we produced 18% premium revenue growth and 34% earnings per share growth. Our year-to-date performance, highlighted by an 87.6% MCR, a 6.9% adjusted G&A ratio, and a 4.7 percent pre-tax margin is squarely in line with our long-term targets. Adjusting for the marketplace risk adjustment true-up and the accounting impact of the revenue pass-through, our underlying pure period year-to-date MCR was 87.2 percent. Year-to-date, we produced 19 percent premium revenue growth and 21 percent adjusted earnings per share growth. Medicaid, our flagship business, representing 80% of enterprise revenue, continues to produce very strong and predictable operating results and cash flows. The rate environment is stable. COVID costs have tempered, and we are executing on the sound fundamentals of medical cost management. The ongoing and consistent high earnings quality in the first six months produced a reported MCR of 88.1%. Our diversified geographic footprint and mix of products, including management of high-acuity members, provides us with an excellent earnings ballast. Our high-acuity Medicare niche, serving low-income members, representing 13% of enterprise revenue, continues to grow organically and outperform our long-term target margins. The year-to-date reported MCR of 86.7% even while still pressured by the cost of COVID-related care, is below the low end of our long-term target range. Each of our products, DSNP, MAPD, FIDESNP, and MMP, contributed to this favorable result. Marketplace, at 7% of enterprise revenue, is tracking to return to profitability in 2022 on a pure period basis. We have succeeded in keeping the business small, keeping it silver and keeping it stable. The true-up to 2021 risk adjustment is largely due to the surge of special enrollment period membership that we experienced in the last half of 2021. On a pure period basis, 2022 is on track to achieve a low single-digit pre-tax margin. In summary, we are very pleased with our second quarter and year-to-date performance. We executed well, delivered solid operating earnings, and continued to deliver on our growth strategy. Turning now to our 2022 guidance. We now project premium revenue to be approximately $30 billion, or $750 million above our previous guidance. Our updated 2022 guidance represents a three-year 23% compound annual growth rate since our pivot to growth in 2019. Excluding the estimated impact of the redetermination pause, our three-year compound annual growth rate is 18%. We are also increasing our full-year 2022 adjusted earnings per share guidance to at least $17.60. Our increased 2022 outlook features strong premium revenue growth of 12%, which includes the impact of our conscious decision to reset the size and scope of our marketplace business, a pre-tax margin at the midpoint of our long-term guidance range, and strong earnings per share growth of 30%. We have purposely remained conservative in our full year 2022 earnings guidance. Our year-to-date underlying performance is highlighted by effective management of medical costs, both COVID and non-COVID, that were favorable to our expectations. In this environment, which is still being affected by the emergence of new COVID variants, it is prudent to remain cautious in forecasting medical cost trends. In the first half of the year for Medicaid and Medicare, which account for 93% of enterprise revenues, we produced MCRs at or below the low end of our target ranges. We believe it is prudent to project MCRs to be within the target range for the second half of the year. Bear in mind that our target MCR ranges result in industry-leading margins. With that being said, if we were to repeat our first half performance with respect to medical cost management in the second half, then it is highly likely we would outperform this full-year earnings guidance. Turning now to an update on our long-term strategy for sustaining profitable growth. We remain confident that we will deliver on our long-term growth targets of 13 to 15% premium revenue growth and 15 to 18% adjusted earnings per share growth on average over time and sustain 4 to 5% pre-tax margins. Our recent performance is supportive of that outlook. Our model for organic growth remains sound. In Medicaid, our market share is high enough to be relevant to our state-based partners and gives us sufficient scale, but low enough to provide an environment for market share gains. Although it has been difficult to measure during the pandemic, we have grown market share in many of our states. The political landscape remains focused on reducing the uninsured population, favoring government-sponsored programs, and driving underlying growth in our current footprint. The economy has had a significant impact on the low-wage service sector as well. We continue to believe the post-pandemic Medicaid rolls will be higher than pre-pandemic levels. On the RFP front, our past track record gives us confidence in successfully retaining the Medicaid contracts that are currently in a re-procurement process. Our RFP responses have been submitted in Mississippi, California, and for Texas Star Plus in our pending evaluation and subsequent award announcement. We are well positioned to retain these contracts due to our track record of operational and clinical excellence, standing and reputation, innovation, and the demonstrated ability to write winning proposals. With multiple new RFP opportunities over the coming years, we remain confident in our ability to win additional new state contracts. We submitted our proposals in the states of Iowa and Nebraska and have many other new state business development initiatives well underway. In Medicare, the rate environment and demographic trends remain supportive of sustainable growth. Additionally, we have opportunities to further penetrate our Medicaid footprint in both DSNP and low-income MAPD products. Our three distribution channels have achieved a high degree of productivity and have lowered our cost of acquisition. Consequently, we are investing heavily in these channels. In Marketplace, our focus is on keeping it small in the context of the overall portfolio and pricing with a goal of achieving mid-single-digit pre-tax margins. As a result, we will grow this business only as allowed by this pricing strategy. Moving now to our inorganic growth strategy. Our M&A platform continues to execute at a high level. Earlier this month, we announced the acquisition of My Choice Wisconsin's MLTSS and core Medicaid assets for an attractive purchase price of approximately 15% of revenue. This acquisition is highly complementary to our expanding Wisconsin Medicaid footprint and our growing MLTSS business. My Choice Wisconsin serves over 44,000 members and generates premium revenue of approximately $1 billion. We expect the acquisition to be immediately accretive to adjusted earnings and deliver first-year adjusted EPS of 15 cents and 45 cents at full run rate. In addition to being perfectly consistent with our product and geographic growth strategy, the acquisition of My Choice Wisconsin validates the vibrancy and actionability of our expansive M&A opportunity pipeline. With the addition of My Choice Wisconsin, our enterprise MLTSS business will be attached to over $9 billion in premium revenue and over $6 billion of LTSS benefits paid. Over the past 10 months, between Agewell and MyChoice Wisconsin, we have announced nearly $2 billion in acquired revenue, which will be included in our 2023 premium revenue based on the expected timing of closing both transactions. We have now announced seven acquisitions since we embarked on our growth strategy. The five already closed are achieving or exceeding their earnings accretion targets. Given our track record and a pipeline replete with actionable and strategically focused acquisition opportunities, we are confident in our ability to continue to execute on this important dimension of our growth strategy. In summary, the company's financial and operational performance validates our long-term revenue growth strategy and its value creation potential. Turning now to our initial outlook for 2023. While it is far too early to provide specific 2023 financial guidance, I will offer a view of some of the building blocks of our initial outlook for 2023. First, with respect to 2023 revenue, we continue to build the 2023 book of business throughout this year. At this early stage, we have line of sight to nearly 10% growth in 2023 from our strategic initiatives and an early estimate of organic growth. This growth will be partially offset by the impact of redeterminations, which we have spoken about at length, and one or two potential pharmacy carve-outs, the timing and extent of which are uncertain. We are only halfway through 2022, and therefore, additional M&A announcements and new Medicaid procurement wins would add to the 2023 revenue picture. Now turning to 2023 earnings. First, in 2022, we are carrying approximately $3 per share of embedded earnings power, which we expect to be realized in 2023 and beyond. This estimate, which has been updated since last quarter, comprises net effect of COVID and full accretion on M&A earnings offset by redetermination impacts. Second, We expect the core book of business will grow organically. As we have demonstrated in the past, when we grow organically, we achieve our target margins. Third, in the quarter, we have finalized or significantly progressed on some major initiatives which provide earnings upside, two of which are noteworthy. We recently renegotiated and executed a new PBM contract with CVS Caremark. which extends the existing contract term at substantially more favorable pricing. Since pharmacy accounts for 15 to 20% of our medical cost baseline, the improved rate structure will substantially improve our pharmacy economics and resulting medical cost trend. The CVS Caremark relationship has been essential to our delivery of excellent pharmacy service to our customers and members and has enabled strong cost control. We are very pleased to have extended this relationship. And secondly, we intend to move permanently to a remote work environment, a model we have been working under successfully for nearly two years. As a result, by the end of this year, we expect to formalize a reduction of our real estate footprint by approximately two-thirds, yielding substantial and sustainable G&A savings. These building blocks aggregate to a very attractive earnings trajectory for 2023 and beyond, although the timing of emergence for each of these is still evolving. That being said, with 2022 adjusted earnings guidance of at least $17.60 per share, embedded earnings power of $3 per share, the earnings contribution of organic growth in the operational catalyst we just mentioned, we fully expect our 2023 adjusted earnings to be at least $20 per share. Although it is too early in the cycle to provide specific earnings guidance for 2023, we are very confident in this earnings outlook. We will certainly update this outlook as it evolves, informed by our performance in the second half of 2022 and the ongoing execution of our strategic initiatives. In conclusion, In the second quarter, we performed very well across the enterprise. Our 2022 earnings baseline, our growth strategy is working, and our early outlook for 2023 is strong. We are executing on our long-term strategic plan and delivering results accordingly. Of course, we could not do this without our excellent management team and dedicated associates now approaching 15,000 strong. We have produced these results under the difficult and rapidly changing circumstances of the pandemic. To the entire team, I once again extend my deepest thanks and heartfelt appreciation. With that, I will turn the call over to Mark for some additional color on the financials. Mark?

Thank you, Joe, and good morning, everyone. Today, I will discuss some additional details of our second quarter performance, our strong balance sheet, our updated guidance for 2022, and some initial views on the building blocks of our 2023 outlook. Beginning with our second quarter results. In Medicaid, our reported MCR was 88%. Normalizing for approximately $350 million of pass-through payments in our Texas plan, our reported MCR improves to 87.4%. This strong performance better than the low end of our long-term target range, was driven by strong medical cost management and lower utilization. The net effect of COVID in the quarter was a modest 20 basis point increase to our reported MCR. In Medicare, our reported MCR was 86.9%, also better than the low end of our long-term target range. During the quarter, the net effect of COVID increased our reported MCR by 370 basis points as BA.5 and other variants resulted in an increased inpatient expense. This pressure was more than offset by favorable risk adjustment and strong medical cost management. In Marketplace, our reported second quarter MCR of 91.2% was inflated by a final true-up of 2021 risk adjustment transfer payments. Normalizing for this out-of-period item, our second quarter MCR was 85.7%. Recall, our marketplace business was more than twice the size last year, so the prior year settlement had a disproportionate impact on the current year. Second quarter pure period results were impacted by higher utilization due to the carryover effects of 2021 special enrollment period membership and approximately 50 basis points of net effect of COVID. We remain on track to return our marketplace business to profitability on a pure period basis in 2022. In aggregate, the net effect of COVID was consistent with our expectations and decreased net income by 68 cents per share in the quarter. The full year outlook for the net effect of COVID remains at $2.50 per share. Putting it all together with the two adjustments I described, our reported second quarter MCR for the consolidated company of 88.1% improves to 87.2%. Similarly, our reported pre-tax margin of 4.4% increases to 5%. and the reported G&A ratio of 6.8% restates to 7. We continue to expect our full-year 2022 G&A ratio to be consistent with our long-term target, reflecting fixed-cost leverage on our growth and ongoing discipline. Our results, as reported and normalized, display the strong performance of our second quarter and the continuing earnings power of the business. Turning now to our balance sheet, our reserve approach remains consistent with prior quarters, and we remain confident in this reserve position. Days and claims payable at the end of the quarter, normalized for pass-through payments which inflate DCP, was 50.4, consistent with prior quarters. Our capital foundation remains strong. Debt at the end of the quarter was 1.9 times trailing 12-month EBITDA, and our debt-to-cap ratio was 45.9%. On a net debt basis, net of parent company cash, these ratios fall to 1.7 times and 43.7, respectively. Our leverage remains low. All bond maturities are long-dated, on average eight years, and our weighted average cost of debt is just 4%. We harvested $165 million of subsidiary dividends in the quarter, and we purchased approximately 660,000 of our shares for approximately 200 million. Parent company cash at the end of the quarter was 210 million. With substantial incremental debt capacity, cash on hand, and strong free cash flow, we have ample cash and capital to drive our organic and inorganic growth strategies. Now, a few comments on our 2022 guidance. We have increased our full-year premium revenue guidance by $750 million to approximately $30 billion, driven by two components. Approximately $250 million reflecting the latest extension of the public health emergency and the related delay in resuming redetermination of Medicaid eligibility, and approximately $500 million for the second quarter outperformance and some additional Texas pass-through revenue. We also raised our full year 2022 adjusted earnings guidance by $0.50 per share to at least $17.60. The increase is driven by three items. Second quarter performance above our expectations by about $0.25 per share. Margin on the additional revenue from the extension of the public health emergency, which we estimate at about $0.15 per share. And additional net income of $0.10 per share in the second half, driven by the recent rise in interest rates. Normalizing for the out-of-period risk adjustment item of $0.44 per share, our second quarter outperformance increases to about $0.70 per share. We have offset any extrapolation of this second quarter outperformance for the rest of the year with some tempered conservatism. Our first half MCRs outperformed the lower end of our long-term target ranges in both Medicaid and Medicare. In the second half, we are projecting those same ratios to be more in line with our long-term target ranges. As Joe mentioned, our updated guidance will prove conservative if the strong medical cost management and lower utilization we saw in the first half continues through the rest of the year. We expect second-half earnings to be distributed fairly evenly between the third and fourth quarters. Finally, some additional color on the building blocks of our initial outlook for 2023, beginning with premium revenue. Our initial outlook is for the announced pending acquisitions of AgeWell and MyChoice Wisconsin and organic growth to drive approximately 10% growth off our current 2022 premium revenue guidance. We expect this growth to be partially offset by redeterminations and potential pharmacy carve-outs. Our 2023 revenue outlook will continue to evolve as we make progress on our in-flight strategic initiatives, including acquisitions and procurements. Turning to adjusted earnings. First, our embedded earnings power is now approximately $3 per share, comprising 250 net effect of COVID, $1.50 from our closed and pending acquisitions when at target margin, offset by approximately a dollar from the eventual impact of redeterminations. While it's too early to guide on the emergence of these components, we offer some perspectives on what might impact 2023. Within the 250 net effect of COVID, corridors in just three states are the primary driver. We expect to see upside here as states terminate these corridors, as Ohio already has. and the lingering cost of COVID inpatient services dissipates to a new normal. Our acquisitions typically reach target margin in the second year of operations. We feel confident we will see a significant portion of the $1.50 emerge in 2023 as Affinity and Cigna Texas will be in their second year, and Agewell and My Choice Wisconsin will make their first year contributions. We now assume redetermination will begin in October and we expect to lose approximately half of the 750,000 members we gained since the start of the pandemic. These membership attrition assumptions yield a 2023 headwind of 1.2 billion in revenue and 70 cents per share on EPS. Several highly credible data points give us confidence that the margin on members lost through redetermination have a similar profile to our overall membership. Second, the attractive growth of our legacy business and the associated margin partially offset by potential pharmacy carve-outs will yield incremental earnings in 2023. Third, as Joe described, we see a combination of new operating drivers that should enhance our 2023 earnings growth, including our recently renegotiated PBM contract, which improves the economics on 15% to 20% of our total medical cost spend, and our expected real estate reduction. We plan to reduce the roughly 2 million square feet of leased office space by approximately two-thirds by the end of the year. Finally, we expect higher interest rates to translate into correspondingly higher net investment income. These building blocks provide an early view of some of the most impactful components of our outlook for next year. Our evolving outlook on 2023 will be informed by our performance in the second half of 2022, as well as the ongoing execution of our strategic initiatives. We now feel confident in setting our initial outlook for 2023 adjusted EPS to at least $20. This concludes our prepared remarks. Operator, we are now ready to take questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your hands up before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2.

At this time, we will pause momentarily to assemble our roster. The first question today comes from Josh Raskin with Nefron Research.

Please go ahead.

Hi, thanks. Good morning. Just a question on the risk transfer payable update. Was that more your membership came in healthier than expected? You know, you had codes rejected or something, or was it the market was overall sicker? And how does that inform your pricing and thoughts around the opportunities for growth next year in the exchanges?

Sure, Jeff. Really, it was a function of the surge of special enrollment membership we experienced last year. If you recall, we took on 250,000 members between March and the end of the year. And, of course, we had to really gear up and scale up to service that membership, including risk adjustments. So I think part of it was keeping pace with the surge of membership and getting the risk scores. I think part of it was the acuity of the membership. And I think another part of it was just the imprecise nature of actuarial estimations given that unstable environment. The good news for this year is we became aware of this emerging trend early in the quarter. as we were developing our final pricing in the marketplace. And we're able to take the current view of the acuity of this population into consideration as we filed our final prices for 2023. Okay, thanks.

The next question comes from Matthew Borsh with BMO Capital Markets. Please go ahead. Matthew, perhaps your line is muted. Sorry. Can you hear me? Yes, we can. Okay.

I apologize. I have a new phone here. So, I was just going to ask about another item in the quarter, which is the prior year reserve development. It looked like you got a little over $100 million I mean, I'm not saying it's a net benefit, obviously, because you're replenishing reserves. But can you just comment on that? Because I think in the year-ago period, it was pretty much zero.

Yeah, sure. Matt, good morning. It's Mark. I think you're looking – You're looking at the year-over-year change. We had a little more prior-year development this second quarter than we did a year ago at this time. And that's not unusual. The way development happens is not always the same year-over-year. The way our providers submit claims and the way our internal operations, including payment integrity work, is a little different year-over-year. So yeah, the pattern's a little bit different, but what's more important is I'm reporting our DCP at 50.4, you know, which versus a year ago at 48 is clearly up. The other thing that you guys look at a lot of times is just the growth in premium versus the growth in reserves. My reserves are up 28% year over. My premiums are up 18. So I feel really good about where I'm reserved. I think we're in a good spot.

Okay, fantastic. Thank you. The next question comes from Steven Baxter with Wells Fargo.

Please go ahead.

Hi, thanks for the question. It was interesting to hear you talk about the several highly credible data points suggesting the decremental margin on the lost Medicaid redetermination membership would be in line with the portfolio average. Obviously, this is an area of concern or uncertainty for the market. We'd love if you could maybe help us understand what you're looking at to better understand this issue and reach that conclusion. Thank you.

Sure, Stephen. I'll kick it to Mark for some of the actual numbers. But as a matter of routine, in the Medicaid business, one needs to understand the duration of its membership. Duration could have an impact on the acuity of the population. So it's something we routinely look at. I will tell you that during the pandemic, the duration of membership, the length of time people were on the Medicaid rolls didn't extend all that much. And I will tell you that the differences in acuity as measured by medical care ratios is not that much different on short-duration members versus long-duration members. We have lots of other actuarial and medical economics data points that suggest that the members that will leave will leave at portfolio averages, but I'll turn it to Mark for a little more color on that.

Sure. Just a couple of data points that we track really closely. Remember, within our Medicaid business, there's TANF and CHIP. There's expansion and there's ABD. So we look at these within each of those. One of the first things we look is, you know, the duration. What percentage of our members are with us for more than a year? In TANF, CHIP really didn't change meaningfully. ABD didn't really change meaningfully. Expansion is up a little, not huge. Within those populations, though, we also then compare what's the MCR for the folks that are maybe two years and longer with us versus the MCR for those less than a year. That's the durational acuity concept that Joe mentioned. You know, it's really flat between those two cohorts in TANF chip. It's pretty flat on ABD. It's a really stable population. So it's up a little in expansions. On the percentage of members with no claims, another one that's good to look at, TANF CHIP, pretty flat. ABD, once again, flat. We're seeing a little bit more in expansion. So could you argue that there's going to be a little bit of pressure with an expansion? Possibly. But, you know, at a third of the overall Medicaid book, any impact there gets diluted.

So we really don't see this as a big headwind. The next question comes from AJ Rice with Credit Suisse.

Please go ahead.

Hi, everybody. Maybe just continuing to triangulate around the re-verification question. So when you're giving those numbers for next year, are you assuming the full impact of the re-verification plays out next year? I know some of your peers have talked about you know, states taking as much as 10 months to gear back up fully and therefore you'd sort of have a partial impact next year and the full impact annualized in 2024. Can you, those numbers you threw out, is that the full impact or is that a partial year and you expect more spillover into 2024?

Two concepts, AJ and Joe. First, we always forecast and plan according to the status quo, and since the PHE right at this point will end in October, that's our planning assumption. We all expect it to be extended to the end of the year, but that's a separate issue. As we built up our models on a state-by-state basis based on conversations with the state and how they plan to execute the redetermination process, So the buildup of what we do is very much bottoms up. We do, in our forecast, most of the impact is 2023. Some of it spills over into 2024. The key numbers are $3.2 billion of Medicaid revenue gained as the 750,000 membership growth occurred. It'll ultimately settle at 1.6 billion, and that will roll out mostly in 2023 at 1.2 billion. of $400 million spilling over into 2024. Mark, any color to add?

Yeah. AJ, I just always remind people to do the member month, Matt, because it gets complicated, right? If the PHE ends in October, the stipulation is that states have a year from the end of PHE to be done. So they've got to be done next October. But if you look at the member months, it's as Joe mentioned. I've got 1.2 of headwind in for 23 and another 400 in for 2024. Okay, great. Thanks so much.

The next question comes from Nathan Rich with Goldman Sachs.

Please go ahead.

Hi, good morning. If I could ask a two-part question on the 2023 guidance that you gave. For the 10% growth in premium revenue, And obviously that excludes redeterminations. If you back out the impact of acquisitions, it looks like low single-digit revenue growth. Could you maybe just talk about how that breaks down by line of business? And then you mentioned having industry-leading margins, and I think doing the quick math on the premium revenue outlook, and earnings, it looked like you were, you know, kind of continue to be at the top end of that range. So could you maybe just talk about margin potential from here as we think about the next several years?

First on the growth assumptions, we've included a modest but early view of our organic growth trajectory for next year. If you look back at our investor day models in Medicaid, We say that just by being in Medicaid, with premium yield and additions to the Medicaid rolls, we're expecting 4% growth. In Medicare, that same phenomenon, yield and growth in the Medicare population, both on agents and penetrations of managed care, will add about 7%. So when we talk about organic growth, we're talking about merely yield and the growth in the market. And if you weight that at 80% and 13% of revenue, you're talking about perhaps 5% growth just by being in those markets. Then, of course, we have our strategic initiatives, which are only halfway done. We're only halfway through 2022. So we have far more to do on building the book of business for next year. So we're really happy that at this early stage, between our strategic initiatives and an early view of organic growth, we're already accounting for 10% over the 2022 baseline. Your second question again, please?

Yeah, sorry. Just on the margin opportunity, you know, given that the business is kind of operating today at the high end of the long-term target.

Well, you know, one of the reasons why we settled in at $17.60 for our guidance is, you know, let's frame where we are. We just printed two $5 quarters, you know, revenues growing at 18%, earnings per share growing at 34%. On both a six-month and a three-month basis, our pre-tax margins are 5% and after-tax margins are at 3.7%. And we did that by outperforming the ranges of our MCRs, which produce best-in-class industry margins. So to continue to forecast that level of outperformance going forward, we thought was a bit imprudent and perhaps too aggressive. So we were purposely conservative to merely forecast the rest of the year as operating within our long-term target MCR ranges. We're going to end the year at 4.5% pre-tax margin, 3.3% after-tax, and MCRs squarely in those long-term targets. which again produce best-in-class industry margins. We're always looking for ways to improve the performance of the business. We mentioned two very significant operational catalysts going forward, the renegotiation of our pharmacy contract and the fact that we're moving to a permanent remote work strategy. So we're constantly working the system to try to find ways to attain fixed cost leverage, drive down our G&A ratios, and perform at the top end of our long-term ranges for the MCR.

Thank you. The next question comes from Kevin Fishbeck with Bank of America.

Please go ahead.

Great. Thanks. I guess one quick clarification and then the actual question. When you said 10% revenue growth for next year, then you said partially offset by redeterminations and carbon. Was that 10% number including those, or were you saying it was 10% kind of giving us a sense of how you normally grow, but then net it'll be a little bit less than 10 because of those other items?

So, hey, good morning. It's Mark. The 10% is the announced but not closed acquisitions of AgeWell and MyChoice Wisconsin, as well as that organic growth concept that Joe described, the 4% in Medicaid, more like the 7% in Medicare. The other items that are adjustments, but they're a little vague at the moment, we're still working through those.

Okay, so 10 minus something.

That's correct.

I'm trying to think about it right now. Okay. And then I guess as you think about – the COVID impact, I guess I'm struggling a little bit with how you talk about the COVID impact, because it seems like it's a little bit different than how some of your peers are talking about the COVID impact. Because like with Q2, you seem to be saying that COVID was a headwind, but that you were able to offset it with medical management, where most of the companies seem to kind of be saying, you know, for whatever reason, volume didn't come back the way that it normally does in Q2. And, you know, they're being cautious on the back half of the year. You're still being cautious on the back half of the year, but I'm just trying to understand exactly what you think happened in the quarter. Was it an industry-wide phenomenon, or do you kind of view, like, your controlling trend below, and it's kind of more outperformance or trying to be more sustainable versus maybe a blip in how people use utilization during COVID troughs and peaks and therefore maybe a little bit less clear about what happens in the back half? Thanks.

Sure, Kevin. We're pretty disciplined in how we measure the COVID impacts, both the direct cost of COVID-related care and the offsetting curtailment. it's been uncanny that as COVID infection rates spike and therefore the direct cost of COVID care increase, the offset of utilization curtailment has pretty much offset the direct cost of COVID-related care. Now, you're never sure whether that's going to continue to be that highly correlated, but as I look back over every quarter during the pandemic, that has basically been the case. So for the most part, our COVID costs is about two-thirds the corridors, the three remaining corridors, and one-third the net effect of COVID direct offset by curtailment.

Yeah, just to build on that, our definition of the net effect of COVID has been consistent across the two and a half years here of the pandemic. As Joe mentioned, it's about two-thirds corridors. And then the rest is COVID inpatient direct, which we can measure. And then the offsetting curtailment of certain services where we're just not seeing the youth. We're seeing that relationship be very consistent. We laid out the different impacts, line of business by line of business. You saw our Medicaid and marketplace businesses had a relatively light impact. Medicare was a little higher at 370 bits. That's the been typically tracking more around 200 bits So that one's just a little bit higher line of business the line of business it bounces around but across the portfolio It's pretty much tracking where we'd expect. We're still at that two dollars and fifty cents for the full year the final Please go ahead.

Yeah, I was gonna say the final proof point is that our effective medical cost management actually contained utilization in areas that were unaffected by the COVID infection rate, which would suggest that our utilization routines, our payment integrity routines, all the things we do to effectively medically manage a population are working in areas that were unaffected by COVID. So we're operating well and managing medical costs very, very well in areas unaffected by COVID.

I guess the thing I don't understand about the corridor comment, because if you're at or above your target margin in Medicaid, but you're saying that when corridors go away, then that we should think about you permanently being able to operate above the Medicaid business. Because it seems like you're already at your peak margin in Medicaid. So if corridors go away, and that's the base to be thinking about going forward, then you'll be permanently above that. So I'm just struggling a little bit with kind of how to think about corridors being the net COVID.

We understand the math behind that. The simple math is if you take our embedded earnings and just convert it to actual earnings, it would suggest that the margins pop slightly north on a pre-tax basis of the top end of our range. But two things. One, embedded earnings isn't guidance. And two, it doesn't all emerge at one time or within one year. Now, with respect to the corridors, there's only three that matter that remain. And one of them has already been eliminated for October. The two that remain are Mississippi and Washington. And if they persist beyond the pandemic, then they're part of the earnings baseline and will live with them for a longer period of time. But we're pretty optimistic that they'll fall away over time.

And, Kev, just to put a point on that, that means that 15 of our 18 Medicaid states are not constrained by corridors, and that's part of where our margin story is.

All right. Great. Thanks. The next question comes from Michael Haas with Morgan Stanley.

Please go ahead.

Hey, thanks, guys. So just real quick first on the risk corridors. So 15 out of 18 states aren't constrained. So you don't have any longstanding risk corridors that are pre-COVID in any of those other 15 states?

We do. That last conversation was specifically around the net effect of COVID and COVID-related corridors. Pre-pandemic, a number of states had different mechanisms that did constrain some profitability, but that's more our legacy profile. So we're talking here specifically about, you know, COVID era corridors.

Got it. But presumably you're in a net payable position in the other 15 states in some of them, right?

To a small degree, yes. And that changes year to year.

Okay. Got it. Thanks. And then my real question is, So it looks like you guys are now expecting low single-digit margins this year for exchange. But heading into the quarter, and I guess even this year, the shift to silver-focused pricing efforts, there's seemingly a lot of confidence in improving to mid-single digits. But MLR this quarter, even without the risk adjustment payable, is still much higher than the street at 85%. And now year-to-date, you guys are tracking the mid-80s. Just curious, What happened there? You mentioned higher core utilization. What are the dynamics you're seeing, and was there some mispricing related to that?

Well, I mean, in summary, we're 200 to 300 basis points off on 7% of our revenue, so putting it in perspective, which we're not happy about. We want to operate in the low 80s. The business breaks even at 85, and we're projecting to do 84 or better for the year, which would be modest profitability. First and foremost, we repositioned a book of business. That was the tall order for 2022. Keep it small, 7% of revenue. Keep it silver, 75% of our membership is now silver membership. Keep it stable, two-thirds of our membership is now renewal membership when that was completely the opposite in prior years. So we have the book of business positioned very, very well. Now we'll work on the 200 to 300 basis points of pressure that is pressuring our MCR. And with the pricing we put in for 2023, on average 13% to 14% in some states higher, we feel good about getting to those mid-single-digit target margins.

Got it. Thank you. The next question comes from George Hill with Deutsche Bank. Please go ahead.

Yeah, good morning, guys, and thanks for taking the question. I guess I was just going to ask you about the new contract with CVS. I don't know if there's any chance that you can kind of quantify it. savings opportunity looks like, or if there's any meaningful change in the scope or the services that are being provided?

No change in the scope of services. We have a very good balance between what we operate and what they operate. No change in that. The agreement was extended through 2026. We're not going to talk about the pricing of it. We obviously wouldn't have mentioned it if it wasn't an earnings catalyst. But 15% to 20% of our medical cost is pharmacy-related, and the pricing document we received was, in our view, noteworthy to discuss as an earnings catalyst for 2023 and beyond. But at this point, we're not going to actually size the pricing.

Okay. So maybe sizing the pricing isn't the right way to think about it, but is the – If we use that range, is there a way to think about how we should think about what the change to MLR can be as it flows through the income statement, or I guess just kind of any way to kind of quantify the earnings contribution to you guys, not necessarily the pricing of the contract?

As I said, at this point in time, we've sized the size of the contract $4 to $5 billion a year of pharmacy spend, but no, we're not yet prepared. When we give 2023 guidance, The CVS Caremark contract would likely be a meaningful contributor to that guidance, and we'll potentially talk about it specifically then.

Okay. We'll hold on. Thank you. The last question today comes from Stephen Valliquette with Barclays.

Please go ahead.

Hey, thanks. Good morning, guys. Yeah, I was also going to ask about the exchange business, but a lot of that was covered. I guess the follow-up question around that though, Joe, when you kind of mentioned those 13 to 14% premium increases that you put in place, how does that stack up relative to your medical cost trend expectation for exchange book for next year? And something if you're mainly focused on margins, but I guess do you expect profit growth within that book the way it stands right now for 23? Just want to confirm that. Thanks.

Yeah. strategy for the marketplace business is to target mid-single digit pre-tax margins and let the revenue float up and down accordingly pursuant to that pricing strategy. Based on the early read, where we actually now have seen competitive pricing, the price increases we put in in a handful of markets remained very competitive. If we were number one or number two or a close number three or four in the market, we've maintained that position. So the early read, only in a handful of markets, is that not only do we believe our pricing has appropriately captured trend, but we maintained our competitive position so the book of business shouldn't materially change.

The only thing that I add to that is now that we understand current year performance, The base period that we're jumping off, we feel much better about. So we're pricing in a trend that we feel good about going into 2023. Joe mentioned the 13% average rate that we're putting into the market. The only other thing that maybe isn't obvious as you build your model is that the assumption in there on risk adjustment, right? Those are the three big drivers, trend, the changes in risk adjustment for the underlying acuity of the population, and of course, price. You put those things together, and we feel very well positioned for the return to that mid-single-digit pre-tax next year.

Got it. Okay. All right. Thanks. This concludes our question-and-answer session and concludes the conference call.

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