Q2 2004 Aetna Inc. Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: Good day, everyone, and welcome to Aetna Incorporated second-quarter 2004 earnings release. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. David Entrekin, Vice President of Investor Relations for Aetna Incorporated. Please go ahead, sir.

DAVID ENTREKIN, IR DIRECTOR, AETNA INC.: Good morning and thank you for joining Aetna's second-quarter 2004 earnings call and webcast. This is David Entrekin, head of Investor Relations for Aetna and with me this morning are Aetna's Chairman and CEO, Dr. Jack Rowe, President Ron Williams, and Alan Bennett, our Chief Financial Officer. Following their prepared remarks, we will be happy to answer your questions.

During the call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently expected results are described in our 2003 Form 10-K. Pursuant to SEC Regulation G, we have provided reconciliations of metrics relating to the Company's performance that are non-GAAP measures in our second-quarter 2004 press release, financial supplement and 2004 guidance summary. These reconciliations are available on the Investor Information portion of the Aetna.com Web site.

Also, as you know, Regulation FD limits our ability to respond to certain inquiries from investors an analysts in non-public forums, so we invite you to ask all questions of a material nature on this conference call.

Now, let me turn the call over to Dr. Rowe. Jack?

DR. JACK ROWE, CHAIRMAN, CEO, AETNA INC.: Thank you, David. Thank all of you for joining us this morning.

I'm very pleased to report operating earnings for Aetna in the second quarter of $1.77 per share. Operating EPS, excluding reserve development, was $1.70 a share, a 34 percent increase compared to the second quarter of 2003.

Net income, which includes net realized capital gains and other items, was $1.79 per share for the quarter, more than double the 87 cents per share reported in the second quarter of 2003. The $740 million tax refund that we announced earlier this month will be recorded in the third quarter and therefore did not affect net income in this second quarter.

The second-quarter results demonstrate our momentum in the marketplace, including membership gains and accelerating topline growth. I would also highlight our excellent progress in maintaining a stable medical-cost trend, achieving ongoing operating efficiencies, our strong cash flow, and exceptionally strong capital position, which will further advance as a result of the significant tax refund we recently announced.

Now, I will review key aspects of our performance and accomplishments in the second quarter, including our commitment to innovation, profitable membership growth based on disciplined pricing, topline revenue growth, medical-cost trends, increasing operating expense efficiencies and, importantly, our unwavering commitment to effective capital management.

Our marketplace strategy places a strong emphasis on innovation, pricing discipline and having the right product in the right market. In the second quarter, we continued to roll out new plan designs and improved tools in target markets, enabling more brokers and consultants to quote on new case opportunities for Aetna. These efforts are meeting with excellent market success, particularly in the middle and small group markets where Aetna has historically experienced low penetration.

In the second quarter, medical membership increased by 95,000 members and now totals more than 13.4 million. This growth comes despite continued reductions within existing accounts of 30,000 members in the second quarter. Aetna's membership growth once again represents both higher customer sales and increased customer retention. This brings our year-to-date net medical membership increase to 437,000, a 3.4 percent increase from year-end. We are very pleased with this result and it increases our confidence in achieving our full-year 2004 net membership growth target of 600,000 to 750,000 members. Ron Williams will discuss the details of our membership growth later in this call, including membership increases in other products, such as dental, pharmacy and group insurance.

Topline growth in the quarter was excellent with revenue increasing 9.4 percent overall and 11.3 percent for our Healthcare segment, compared to the second quarter of 2003. The increase in Healthcare revenue includes growth in premiums of 11.4 percent and a 10.1 percent increase in fee income. Topline growth is an important dynamic as we go through 2004 and 2005. This growth is reflective of success in a number of key areas. First, increases in premiums reflect higher membership, particularly in our middle and small-group markets, and our disciplined approach to pricing. Fee income increases reflect growth in our ASC business in 2004 and importantly, our increased sales of other value-added products and services.

We've been very pleased with our management of medical costs in 2004. At the outset of this year, our view of medical cost trend for the year was in the 9 to 10 percent range. At the end of the first quarter, our view of this trend improved to 8.5 to 9.5 percent. Today, based on our results for the first half of 2004, we are further improving our outlook for medical costs. Our full-year 2004 guidance for commercial risk medical cost trend is now improved to a range of 8.5 to 9 percent from the prior level of 8.5 to 9.5 percent. Consistent with the first quarter, all cost categories continued to show moderate trends. Ron Williams will discuss the components of cost trends in the quarter and our outlook for the balance of the year.

Our commercial risk Medical Cost Ratio was 79.1 percent in the second quarter, excluding development, up from the seasonally low first-quarter level. This result is consistent with our expected seasonal pattern and our prior guidance and represents a normalization of our prior low-level of MCR to a sustainable level for the balance of the year. Accordingly, we remain comfortable with our full-year guidance for commercial risk MCR in the range of 78.5 to 79 percent. Ron will discuss Aetna's pricing discipline later in the call.

Regarding operating efficiencies, the second quarter showed excellent progress. Selling expenses in the second quarter increased by 28 million over the second quarter of 2003, reflecting increased sales for new members. In other words, these expense increases were success-based. G&A expenses declined by 59 million for a net decline of total operating expenses of approximately $31 million. This brings our year-to-date net SG&A savings to 67 million, exceeding our initial goal of 50 million for 2004. We remain confident in our ability to continue to achieve operating efficiencies. Alan Bennett will provide details of the expense reductions achieved in the second quarter and year-to-date, as well as updating our expectations for the full year.

At the beginning of this year, we indicated that our performance in 2004 would be characterized by a combination of membership growth across our product lines, topline revenue growth, moderate medical costs, a pricing strategy for the year designed to enhance our underwriting margin per customer, and operating expense reductions which would lead to meaningful margin expansion.

2004 results are solidly on track with an increase in second-quarter pretax operating margin, excluding development, to 9.5 percent from 8.1 percent in the second quarter of 2003.

Lastly, I'd like to discuss our recent announcement of the $740 million tax refund and our commitment to effective capital management. We announced the tax refund on July 7, following approval of this issue by the appropriate governmental bodies. In the context of this developing issue, the Company appropriately abstained from purchasing shares in the market during the second quarter. We are very pleased with this development and the new cash that it will provide to the Company. Let me note that this will truly be a new net inflow of $740 million of cash to Aetna, as it was not previously recorded on the Company's balance sheet. The timing of the actual payment to Aetna has not been finalized but we expect receipt of the funds in 2004.

Very importantly, management's commitment to the effective deployment of capital is unwavering. While it would not be prudent to discuss the …