Centene Corp (CNC) — Q2 2023 Earnings Call Transcript

Thank you, Rocco, and good morning, everyone. Thank you for joining us on our second quarter earnings results conference call. Sarah London, Chief Executive Officer; and Drew Asher, Executive Vice President and Chief Financial Officer of Centene, will host this morning's call, which also can be accessed through our website at centene.com. Ken Fasola, Centene's President, will also be available as a participant during Q&A. Any remarks that Centene may make about future expectations, plans and prospects constitute forward-looking statements for the purpose of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in Centene's most recent Form 10-K filed on February 21, 2023, and other public SEC filings. Centene anticipates that subsequent events and developments may cause its estimates to change. While the company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. The call will also 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 2023 press release, which is available on the company's website under the Investors section. The company is unable to provide a reconciliation of certain 2024 measures to the corresponding GAAP measures without unreasonable efforts due to the difficulty of predicting the timing and amounts of various items within a reasonable range. With that, I would like to turn the call over to our CEO, Sarah London. Sarah?

Thank you, Jen, and good morning. Thank you for joining us for Centene's Q2 earnings call. Our second quarter performance demonstrated Centene's ability to deliver solid results amid a dynamic healthcare landscape. We reported $2.10 of adjusted diluted EPS for the quarter and lifted our 2023 premium and service revenue forecast by another $1.8 billion. We now expect to deliver at least $6.45 of adjusted EPS for full year 2023, a $0.05 increase compared to April guidance. We are proud of the progress we are making with respect to the execution of our strategy, achieving operational milestones, while delivering on the financial commitments we've made to our shareholders. Importantly, our balanced portfolio of core businesses delivered strong second quarter financials, with Marketplace growth and Medicaid performance both running slightly ahead of expectation. Let me provide a few updates related to our progress in each business line, and then share the latest on our value creation work. Let's start with Medicaid. Since our Q1 call, Medicaid redeterminations have formally kicked off in every one of our 30 active states. The time our team spent over the last 18 months preparing for redeterminations has positioned us well to support our state partners, establishing timely information exchange and shared workflow as well as reaching out directly to members to provide education around process and enrollment options. Year-to-date, we have made 9 million outreach attempts, with early indications of higher-than-normal member engagement. These outreach efforts, inclusive of more than 15,000 community events, also contribute to our ability to recapture members, even if initially disenrolled as part of redeterminations. We are actively tracking the number of members that we are recapturing post-procedural disenrollment and expect the percentage to meaningfully advance as this process unfolds. At an enterprise level, net Medicaid membership is consistent with expectations. We have seen ebbs and flows from month to month as states continue to evolve and refine their processes. Given the recent news that CMS is requiring certain states to pause redeterminations and reinstate members who were dropped for procedural reasons, we will be closely tracking any impact this may have on the membership slope over the next few months. Much of the redeterminations' journey remains ahead, and we continue to monitor the major levers, including rate, acuity and membership. Based on our most recent analysis and informed by member lists and acuity projections from our state partners, our expectation around member acuity for 2023 remains unchanged. As we assess who is staying versus leaving, we are tracking consistent with the acuity modeling we discussed on our first quarter call in April. Medicaid rate conversations continue to be constructive. We are consistently seeing states take acuity adjustments into consideration in their rate updates. And at an enterprise level, we remain on track with our expectations for 2023. Overall, we are grateful for the partnership and trust placed with us by the states we serve and for the leadership CMS has shown in helping us to ensure that eligible Medicaid members do not experience unnecessary coverage gaps as states work through the unprecedented scale of this redetermination process. From a Medicaid business development standpoint, we chalked an exciting new business win in June, as our team in Oklahoma was selected by the Oklahoma Healthcare Authority for statewide contracts to provide managed care for the SoonerSelect and SoonerSelect Children's Specialty Plan programs. The team delivered a strong RFP response and was the sole source winner for the Children's Specialty program, designed to serve children and families involved in the child welfare and juvenile systems, including foster care. This represents Centene's 31st state and our sixth Sole Source Foster Care contract. Overall, Medicaid, our largest and longest-running business, delivered strong results in the second quarter, and our market teams continue to prove the value of the local approach, demonstrating innovative and comprehensive support for our members and state partners as we continue to execute against redeterminations in the coming months and quarters. Turning to Medicare. Our quarter-end membership was 1.3 million, with approximately 47% of Medicare Advantage lives associated with value-based care arrangements, a 300 basis point increase from Investor Day as we've added key VBC partners to our network. Second quarter results reflect some slightly higher outpatient claims experience within Medicare during the month of May. Drew will provide more detail on this as well as our bid posture for 2024, but it is worth noting that our increased 2023 adjusted EPS guidance incorporates our latest view of trend and pockets of slightly higher Medicare utilization in the back half of the year should that occur. Given our discussion in Q1 around Stars, I'd like to provide an update on what we expect to see in October and what we are seeing year-to-date around Stars' improvement efforts that will inform future results. As a reminder, on our Q1 call in April, I shared that we expected minimal progress in 4-star plans, but that we anticipated solid overall contract improvement, reflecting the operational investments we have made. With more complete program data, our projection shows some more pressure on 4-star results, but we are still expecting solid overall contract progression, thanks to strong improvements in admin and ops and pharmacy measures, which have been our focus in this first cycle. With several contracts close to the bubble, variability in cut points means we could end the cycle with no 4-star contracts compared to our current single contract representing 2.7% of members. While this is disappointing, we do expect to see meaningful movement in our 3- and 3.5-star bands in October, and roughly 2/3 of our members are in plans showing year-over-year improvement. Pulling up these underperforming contracts represents tangible progress in delivering economic value to Medicare as we look to 2025 and beyond. As a reminder, in Q1, we reset our quality strategy to maximize contracts that reach the 3.5-star threshold, consistent with our renewed focus on serving complex and dual-eligible members beginning with our 2024 bids. Put simply, Star strategy is different when you're managing complex and duals populations. Strong performance at 3.5 stars with Centene's target member mix will give our Medicare business the economics necessary to serve these populations well and support our multiyear performance goals. With this in mind, we have set a revised target of reaching 85% of members in 3.5-star plans by October of 2025. We are closely monitoring in-year Star metrics and continue to see important markers of sustained improvement, consistent with our remarks on the Q1 call. A few examples include: a 27% reduction in year-over-year call volumes resulting from a redesigned member onboarding process that features digital outreach and member self-service; consistent 4-star performance in our core admin and ops metrics; call center service levels for members, providers and brokers at or above target with first call resolution in the mid-80s; year-to-date member provider and broker satisfaction scores in the mid-90s; and the addition of 24,000 new physicians across our Medicare network year-to-date as we look to ensure robust access options for our members. Medicare Advantage provides Centene with an important opportunity to serve low-income and medically complex seniors. It also represents a significant long-term earnings opportunity as we strengthen the overall performance and trajectory of our program. Moving to Marketplace. Our Ambetter Health franchise continues to outperform. This truly differentiated asset creates a unique growth opportunity for Centene, both near and long term. We ended the quarter with 3.3 million Marketplace lives exceeding our previous projections. Our strong membership results were driven by strategic product design, long-standing and differentiated broker relationships and overall market growth. Our large and growing Marketplace platform is well positioned to provide coverage to beneficiaries losing Medicaid eligibility from redeterminations, and we are leveraging our networks and engagement tools to support members during this transition. Where states allow, we are educating our Medicaid members about Marketplace options and are working to proactively communicate with members who we predict will likely be eligible for Marketplace in order to preserve continuity of coverage. During just May and June, Ambetter Health successfully outreached to potential members with more than 160,000 digital touch points via e-mail or SMS as part of our redetermination efforts. We expect this dynamic will continue to fuel growth in Marketplace throughout the remainder of the year and into 2024. Finally, our value-creation initiatives are advancing well. We continue to take a rigorous approach to streamlining core SG&A as we focus and fortify the organization for the future. This includes additional work to standardize our operating model, while maintaining the hyper-local care that differentiates Centene in the market. The implementation of our new PBM contract remains on track, as we've achieved all first half 2023 milestones and look forward to our first go-live dates in early 2024. Our portfolio review work also continues. And in June, we closed the divestiture of Apixio to New Mountain Capital. We structured the transaction to maintain an ownership position as well as a long-term contract because of our view that Apixio's proven artificial intelligence tools are uniquely positioned for this moment in healthcare technology. We believe that partnering with New Mountain will allow Apixio to innovate rapidly through continued investment, while we continue as an influential customer and minority owner. This is a great example of our thoughtful efforts to maximize long-term value as we reposition non-core assets. In parallel, as our value-creation efforts create operating bandwidth, we continue to build our M&A pipeline and look forward to diversifying our capital deployment as strategic opportunities for inorganic growth emerge. Overall, Centene delivered another quarter of solid financial results, while executing against a robust list of transformative initiatives to move our company forward. With half of 2023 in the books, we are excited to leverage our positive momentum as we work to support our state partners throughout the duration of redeterminations, maintain our leadership position in Marketplace, and strategically realign our Medicare Advantage business, building momentum around Star and positioning our products for long-term growth and profitability. Centene's improved earnings power in 2023 is a direct result of the focus and hard work that our organization is demonstrating every single day across our markets. We remain confident in our ability to achieve greater than $6.60 of adjusted earnings per share in 2024 as we continue to execute against our strategic framework, creating value for members, customers, and shareholders alike. With that, I'd like to turn the call over to Drew to review the quarter and our financial outlook in more detail. Drew?

Thank you, Sarah. Today, we reported second quarter 2023 results of $35 billion in premium and service revenue and adjusted diluted earnings per share of $2.10, up over 18% from $1.77 in Q2 of 2022. Our Q2 consolidated HBR was 87.0%, consistent with our expectation and on track with our full year guidance range. Medicaid at 88.9% was a little favorable from the item that we mentioned on the first quarter call, and so far so good on matching rates with acuity, though it is still early in the redetermination process. Medicare at 86.2% was a little higher in the quarter than planned as we also saw May outpatient incurred claims higher than the January through April period, largely in outpatient surgery. With respect to progression, May outpatient trend was higher than April, then it came down in June. July so far is steady with June. Inpatient was on track, and our previous guidance already assumed a Q1 Medicare HBR favorability would not continue. The commercial HBR of 81% was consistent with our expectations, inclusive of continued strong Marketplace growth of 200,000 members in the quarter. Recall that special enrollment period members start with a lower margin profile and therefore, higher HBR than full year members, due in part to risk adjustment mechanics, where the shorter duration doesn't get full credit for health conditions. Though if retained for the following year, the SEP cohort has proven to be attractive. Our guidance contemplates growth to a peak of approximately 3.6 million members in Q4. On the topic of Marketplace risk adjustment, 2022 was recently finalized by CMS, and we received our first view of the 2023 risk adjustment from the Wakely data in June and July. Overall, no surprises in Marketplace risk adjustment. And as of June 30, we have lowered our booked risk adjustment revenue estimates by a cumulative $314 million given the financial condition of a couple of Marketplace competitors. Though we have made this prudent adjustment to our revenue over each of the past five quarters, we plan on fully asserting our rights to collect what we are owed for risk adjustment. To be clear, we have already absorbed this $314 million hit, and this was the biggest reconciling item between the CMS published amount owed to us for 2022 and what was on our books prior to June of 2023. Moving to other P&L and balance sheet items. Our adjusted SG&A expense ratio was 8.6% in the second quarter compared to 8.2% last year, consistent with our updated mix of business. Cash flow provided by operations was $2.5 billion in the second quarter, primarily driven by net earnings and the timing of premium payments from our state partners. Our domestic unregulated and unrestricted cash on hand at quarter end was $200 million. During the second quarter and through July, we repurchased 10.5 million shares of our common stock for $700 million. Year-to-date, we have repurchased 15.4 million shares for $1.08 billion. We also reduced debt by $300 million in the quarter and achieved debt to adjusted EBITDA of 2.9x. Our medical claims liability totaled $17 billion at quarter end and represents 52 days in claims payable compared to 54 in Q1 of '23 and 55 in Q2 of '22. The decrease was driven by state-directed payments that we collected over prior quarters and paid out in a lump sum in Q2, the largest related to California Hospital and Prop 56 payments, representing $713 million or 2.2 days sequentially. Outside of adjusted earnings, during the second quarter, divestiture activity produced a net $0.11 gain in the quarter, and we also recognized additional real estate impairments of $0.02, consistent with our ongoing real estate optimization initiatives. Now let's turn to the full year of 2023. We are pleased with the performance of the company in the first half of the year and are increasing our outlook to at least $6.45 of adjusted EPS for 2023. We are increasing 2023 premium and service revenue by $1.8 billion to reflect an additional $800 million of state-directed payments as well as refinement in Medicaid and Marketplace premium revenue progression throughout the year. Our 2023 guidance continues to include an approximate $200 million Premium Deficiency Reserve for Medicare, as we discussed on the Q1 call. The PDR would be recorded in Q4 of 2023. 2023 guidance also includes a little over $1 billion in investment income, excluding divestiture gain and losses. To go a little bit deeper in Medicaid for 2023, during our first quarter call, we discussed many of our assumptions related to redeterminations that supported our forward projections. We have continued to monitor the actual member data against our projections by state and subpopulation. And as of July, we are tracking consistent with that updated forecast that we provided in April. The matching of rates to acuity continues to be a very important lever for the company as we navigate the redeterminations process. 14 of our 30 states provide rate updates between 7/1 and 10/1 each year. 12 of those have provided us rates, all of which include acuity adjustments. The other two are still working on rate updates. And based upon discussions, we expect those also to include acuity adjustments. Beyond 2023, we are continually assessing our positioning for 2024, whether analyzing redetermination data and rate actions, assessing our 2024 bid assumptions in Medicare against current data, or examining our continued growth and performance of Marketplace. Accordingly, we continue to have confidence in our 2024 adjusted EPS floor of greater than $6.60. To give you a little bit more color on 2024, that $6.60 has an embedded forecasted ballpark $0.80 loss from Medicare Advantage. In other words, if we were merely breakeven in Medicare Advantage in 2024, that $6.60 would be approximately $7.40. Let me close by addressing some of the concerns I've heard over the past few months. Number one, redeterminations. Our early results are playing out well compared to our assumptions, and states understand that in order to have actuarial soundness, acuity adjustments are necessary. Still plenty of execution ahead, but being on track is a good start. Number two, Medicare trend. We came into the year assuming double-digit outpatient trend, and did so again for 2024. And as you know, our Medicare business is under construction for 2024, as we are investing in certain products and pulling back in others. Based upon current forecasts, we expect our Medicare segment to produce approximately 14% of our premium and service revenue in 2024 compared to 16% in the current quarter. And any change in our view of 2024 margin in Medicare, better or worse by the time we get to the fourth quarter of 2023, merely flexes the PDR we booked in 2023 up or down. Number three, growth. We couldn't be more pleased with our performance in the Oklahoma RFP for both broad Medicaid and foster care, and we look forward to the State of North Carolina implementing Medicaid expansion. We continue to execute well in Marketplace, where our industry-best overall position has enabled us to grow Marketplace membership 62% year-over-year. And while yes, we have to get through the rest of redeterminations, we still have value creation initiatives to execute upon and we have years of work ahead on Stars, there's a lot to like here. So while the market trades us at 10x to 11x earnings, we'll keep on executing, buying Centene shares and building up our M&A pipeline to acquire as we create operational capacity.

I still think there's maybe a little bit of confusion out there about the adjustments you're talking about on the exchanges in the quarter. Maybe you could break down those adjustments a little bit further, just so we can really assess core performance. I guess potentially, what was the benefit related to the 2022 plan year that you saw in the quarter? And then you're also talking about lowering booked revenue, I think, related to the financial conditions of some of the potential payers in the market. Is that related to 2022, or 2023, or some combination of both? I guess just trying to understand the underlying components of that $350 million figure you cited a little bit better?

Stephen, thanks for the question. I appreciate it. This is obviously an important dynamic to understand. I'll let Drew walk through the mechanics and address your question, but there's one important point and takeaway that I do want to make sure we don't lose, which is that it is a testament to strength and experience of our Ambetter team, that were not only demonstrating tremendous growth, but ensuring that growth is profitable through prudent risk adjustment planning. And I think that's sort of the overlay to all of this, but let me make sure that Drew walks through all of the mechanics.

Yes, Stephen. It's a bit complicated and defining some of these numbers with public information can be challenging. To clarify, starting with the 2022 risk adjustment, the CMS final announcement indicated we were owed $648 million. According to our 10-K, we had $58 million recorded at year-end, resulting in a $590 million difference. The $300 million-plus figure you mentioned is largely associated with the 2022 year, with a small portion for 2023 due to one competitor being in certain markets for part of this year but is now out. Thus, $300 million is the primary reconciling item. Additionally, as discussed by one of my peers yesterday, there’s margin on estimates, similar to IBNR, where margin is applied because we avoid booking to an exact 50-50 outcome. This margin amounts to about $100 million and doesn't impact the bottom line as it is reestablished annually. Regarding breakage for minimum MLRs, we are performing well under some of our contracts and we also have RADV accruals. By accounting for all these factors, we identified a P&L benefit of $39 million recognized in 2023 for the final amount due from CMS, which was acknowledged during the first and second quarters. Now, looking at 2023, we have approximately $300 million receivable for 2022 and about $1.5 billion net payable for 2023, showcasing the acuity of our population and our estimates, partially guided by the Wakely data we received in June and July regarding our position compared to peers. We also consistently booked this with margin year-over-year, and we will monitor the outcome. Overall, this is a positive indicator, particularly when considering the acuity of the population and our excellent growth this year.

Looking at 2024 and factoring in the PDR, EPS for next year would be down, approximately in the mid-single digits if you compared it to this year. Can you provide a broad overview? Specifically, how much of that reduction is due to Medicaid headwinds from redeterminations? What impact does Medicare Advantage have? I understand you've quantified that loss. Additionally, what earnings are expected from exchanges? Will that increase? There are also benefits from reduced G&A expenses and a share buyback. Any insights to help us navigate these factors would be appreciated. Lastly, could you clarify the PDR and why it doesn't completely offset the anticipated loss in Medicare Advantage for next year?

Thank you, Josh. To address your last question, the accounting rules regarding PDRs mean you only account for the marginal loss and direct costs associated with administering the contract, including distribution costs. However, many items cannot be included in the PDR in that SG&A. This explains why we still anticipate an $0.80 loss embedded in the $6.60 for 2024, despite rolling a projected $200 million, or roughly $0.27, in PDR into next year. If we take a step back, we've shared several aspects of our 2024 outlook, even though we usually provide detailed guidance during our Investor Day in December. For instance, we expect about a $7 billion incremental revenue headwind from Medicaid, which we have indicated previously and is factored into our Q1 figures. Additionally, we anticipate approximately $77 billion in Medicare revenue premiums in 2024, presenting a bit of a challenge regarding volume. As you recall from our Q1 discussion, we projected a shift from 89.8 in 2023 to 90.1, including considerations for potential pressures stemming from discrepancies between acuity and rates, along with some benefits from our PBM arrangement. There are several headwinds in Medicaid, including the previously mentioned $0.80 impact, along with expected improvements in Medicare this year. Regarding the Marketplace, you're correct that there is an ongoing emphasis on margin improvement and the expected growth this year will influence next year, particularly with the influx of new members from the special enrollment period. Lastly, we also have additional factors, such as the annual impact of this year's share buybacks. All these elements contribute to the $6.60 target, which includes the embedded $0.80 headwind, and we anticipate recovering from it over the next few years.

I have a few straightforward questions that I’ll list out, and we can see what you can answer. First, I understand that around 20% of your Medicare Advantage members are currently in 3.5 star plans. I appreciate the guidance of 85% for '26, but I was wondering if you could provide a rough estimate for '25 regarding where you expect to be in October for 3.5 star plans. Then, Drew, you mentioned that 14% of revenue comes from Medicare. What does that indicate about MA membership for next year? Lastly, regarding the rate increases in the third quarter, how are the overall rates comparing to the typical 1% to 2% that you mentioned?

Thank you for the questions, Justin. I'll address the first one and then pass it to Drew. We are still in the early stages regarding cut points. Therefore, our target of 85% for October 2025 remains in place. Regarding revenue for 2026, we're seeing significant improvement, particularly with two-thirds of our members experiencing contract enhancements year-over-year. Although the numbers are not finalized, to give you an overview, this year about 50% of plans are rated at 3 stars or higher. We anticipate that figure will rise to around 90% of members with ratings of 3 stars or better by October. The precise breakdown of those in the 3 or 3.5 star categories will depend on the cut points we have yet to establish, but this illustrates the notable improvement we are observing.

Justin, I tried to provide you with all the relevant information, but let me do some calculations for you. Last quarter, we projected $128 billion in revenue for next year, and we will refine that estimate as we progress through the year. If you multiply that by 14%, you get $18 billion. Our Medicare segment, which includes both Medicare Advantage and Prescription Drug Plans, contributes a couple of billion from PDPs, leading to approximately $16 billion in Medicare Advantage revenue. If we perform a similar calculation for this year, we would estimate around $20 billion in Medicare Advantage revenue. Regarding the third quarter rates, they are consistent with our expectations, but vary quite a bit. When we are heavily engaged in a payable risk corridor in a state, the rates will eventually be adjusted accordingly, though there is no net impact on the company if we are within the corridor. It is not particularly insightful to go through each state individually. However, I want to emphasize that we have been collaborating effectively with our states, and the typical discussions regarding the non-acuity elements of rates are part of the normal process.

Great. Just a couple of questions on kind of capital deployment and raising capital. As far as the MA business, could you talk a little bit about variability of profitability by geography? And obviously, part of that would be, are there opportunities to maybe sell off portions of that business, lower performing portions or whatnot? And I guess related in the other direction is, you mentioned M&A pipeline. Just interested in what the priorities are as you're looking at deploying capital?

Thank you for the question, Lance. Regarding Medicare Advantage, our approach involves analyzing the portfolio on a geographical basis. We are considering larger structural considerations as we prepare for 2024 and 2025, specifically identifying less profitable products we have in our offerings. We addressed this in the Q1 call, emphasizing our focus on bids for 2024, particularly on those less profitable or misaligned products, which we are actively refining. While we are aligning our strategy, it’s more about adjusting and optimizing our Medicare Advantage portfolio to establish a strong growth foundation that complements our focus on lower-income and complex members within our Medicaid segment. Regarding our M&A pipeline, we are concentrating on opportunities that align closely with our three primary business areas, although we also recognize the significance of our strong retail operations in Marketplace and Medicare. The Marketplace presents long-term growth potential, particularly with the rising gig and contract worker market. We are evaluating capabilities needed to develop essential competencies, which are also factors in our overall M&A strategy.

I want to revisit a couple of points regarding the Medicaid reverifications. Clearly, this process is a significant challenge for the states involved. Is it having any impact? It doesn't appear so, but I'll inquire about how things are progressing with the RFPs in the system or those that have been awarded. Have you noticed any spillover effects from that? Additionally, following up on Drew's comments regarding acuity adjustments, could you share the latest insights on how quickly those adjustments might take place as data is received? Are there any states indicating that they are willing to assist in anticipation of some changes?

Yes. Thanks, A.J. I'll let Drew discuss the rates, but it's important to note that several states had a renewal on July 1 and we had very productive conversations. All of those states incorporated acuity adjustments, and we are seeing that trend continue. Regarding the overall Medicaid redeterminations, you are correct that this is an unprecedented effort. We have been very pleased with the level of collaboration from the states, and generally, there is a trend where states are recognizing the value of the public-private partnership we provide. Ken has been actively engaging with our Medicaid directors and governors over the past weeks and months. I'll let him share more details on that, and then I'll turn it over to Drew to discuss the rate discussions further.

Yes. Thanks, A.J. In fact, we were with nearly 14 governors last week, had an opportunity to spin through the Republican Governors Association. And in every conversation we had, redeterminations came up with an eye towards, one, what are we seeing by virtue of the view we have across multiple markets, best methods and genuine appreciation for opportunity that's available to provide more informed counsel to members throughout reach. Sarah mentioned the millions of interactions that we've had, the collaboration with the departments, clearly an eye towards doing the best to give members a chance to make an informed decision. And when there's procedural disenrollments to move quickly to provide the opportunity to get those folks either into the right spot, whether it's in Medicaid or we're seeing opportunities in the Marketplace. Finally, to your point about whether it's going to slow the pipeline, there's no indication of that with respect to procurement and reprocurements. Drew?

Yes, A.J., regarding acuity, over the past year, we have been presenting data to our state partners and collaborating with them and their actuaries in preparation for the start of redeterminations. On behalf of all the payers in the Marketplace and Medicaid, we are working with the state and the associations to advocate for what we believe is appropriate, not just in terms of rates, but also the acuity component within those rates. The rate increases effective July 1, and the two we sold between July 1 and October 1, along with the twelve we have received so far, have all included acuity adjustments with a focus on the impact of redetermination. These adjustments are prospective, except for the few months we have already experienced with redeterminations. We are quite pleased with the partnership with our state partners. There is still much work to be done, A.J., but it is a positive start.

I want to follow up on the comment that redetermination is proceeding as expected. It seems that some news articles suggest things are moving faster. Clearly, the administration's involvement indicates that progress may be accelerating. We would like to hear your thoughts on this. What does the delay really mean? Do you anticipate a significant change in pace, or has your perspective on the pace of enrollment losses throughout the year shifted? Is this slowdown due to the administration's influence primarily about the timing for the remainder of the year, or do you believe it will ultimately affect the number of individuals being redetermined for enrollment?

Thanks, Kevin. We always expected an initial surge of redeterminations because some states are progressing faster than others, while some are taking a more gradual approach. Therefore, the substantial amount of upfront data is valuable but not surprising. This situation has also allowed us to identify potential data issues that may be leading to higher procedural disenrollments than anticipated by some states. Overall, our membership numbers are aligning with our expectations. We are successfully recapturing eligible members who had previously left, thanks to our outreach initiatives, and we are tracking their successful reenrollment. We anticipate that the number will continue to increase throughout the program. Regarding the CMS intervention, we believe CMS has offered states significant flexibility to proceed at a slower pace. Recently, they have adopted a firmer stance toward certain states, but it is still too soon to determine if this will significantly affect the overall trajectory. Some states have been asked to pause for a month, while others are considering extending the grace period for members responding to enrollment requests. It's difficult to say if this slowdown is to ensure states manage the process correctly so they can maintain momentum or whether it will delay those states that initially moved quickly. We will be monitoring this closely in the coming months.

Yes. And then just one last data point. The ultimate sort of roll-off of redeterminations, our view hasn't changed. Still about 65% of what we grew since the onset of the pandemic. 3.6 million members would have been the growth. So 65% of that rolling off would be 2.3 million to 2.4 million members, about $9.5 billion to $10 billion of cumulative revenue. So that's already factored into the numbers we gave in Q1, the $77 billion, for instance, of forecasted Medicaid premium.

I appreciate all the details that you gave us on some of the dynamics in the Marketplace. May be helpful to just to bring it up to sort of the high level if you wanted to share, what type of commercial MLR you're now sort of embedding in the 2023 guide and then in the 2024 floor of at least $6.60? And then inside of that, definitely appreciate the conservatism around some of these receivables from some of these plants out there that are in a tough condition. Would you be willing to maybe just give us a little insight into how you sort of develop that $350 million reduction in terms of sort of, I guess, how that breaks down between Friday and bright? Or just how your methodology works is it just sort of a general level of conservatism that you're building in there?

Yes, the team does a lot of work to analyze the balance sheet positioning and statutory capital of our peers facing potential financial difficulties, looking at the assets backing reserves on their balance sheets. We aim to adopt a conservative approach that varies depending on each carrier's situation. While I am hopeful about recovering the full $314 million, I also want to be realistic and prudent. We will pursue this recovery vigorously because it represents shareholder money. Regarding the HBR for commercial, this includes both Marketplace and about $3 billion of commercial group business, which typically operates at a higher level than our Marketplace business. We still anticipate performing slightly better than last year, when our commercial HBR was 81.1. Considering the SEP membership coming in and the expectation of a higher HBR—though not for a full year—it’s essential to account for that over time. Due to the deductible nature of the commercial business, we should expect a gradual increase in the total commercial HBR, which is generally in line with our expectations.

And again, just important to remember that the performance of the core business and Marketplace is allowing us to absorb that SEP growth. And those members tend to become more profitable in their sophomore year. So assuming good retention, the book that we're building this year will have incremental contribution next year.

Maybe just quickly first on Medicaid acuity adjustments. Wondering where these adjustments assumed are embedded in your 1.4% composite rate increase guide for '23? Or are you now tracking better than that for '23? Trying to understand if these mid-year renewals actually represent upside to your guide? And then on Star, I believe you're originally targeting 20% of members in 4-STAR+PLUS plans at your Investor Day? Now that came down to about 14% to 18% last quarter, and now 0%. I'm trying to understand what exactly changed since last quarter? It sounds like you might not have received cut points yet, or maybe I'm wrong, you did, and they're far more difficult. Was it driven by the two key outlier deletions? I'm just trying to get some more insight on what changed from last quarter to now? And does that even influence your '24 MA growth assumptions?

Yes. Let me discuss the situation regarding our star ratings and rebates. During our Investor Day, we initially targeted 20% of our plans to achieve 4 stars. However, during the Q1 call, due to the overall Medicare rate environment and adjustments we made for the year, particularly regarding our focus on dual-eligible members, we adjusted our target for our population to 3.5 stars as a more realistic objective for our star strategy. Over the next three to four cycles, we will be measuring success based on this new target. I also mentioned during that call that we observed some progress towards 4 stars in certain administrative and operational measures, which are our primary focus in this initial cycle. However, we have several contracts that are precariously positioned, and we are taking a conservative stance by assuming minimal progress. The key point from the Q1 call was that we were anticipating limited improvement in our 4-star aim from a 2.7% baseline. Today, with additional data from HEDIS and CAHPS, we see increased pressure on achieving the 4-star goal. While it's still early to draw conclusions since we lack certain benchmarks, we want to be transparent and have used conservative estimates. This situation does not affect our revenue for 2024, as we have already established that, but it influenced our approach to the 2024 bid construction and considerations for 2025 and beyond. It’s also crucial to highlight that we are witnessing solid improvements in our programs and are methodically working to elevate our underperforming contracts to that 3.5 star level, which is essential for achieving favorable economics. Drew mentioned in the Q1 call that while the financial implications of a 4-star rating are understood, there is a significant economic benefit, ranging from 3% to 6%, associated with reaching the 3.5 star level. Given that our population is predominantly dual-eligible, these financial benefits align well with the performance we aim to achieve.

And Michael, on the 1.4% composite forecasted rate that we laid out at Investor Day in December of '22, that would have partially reflected our view at the time of what we thought might be necessary for acuity adjustments. But the reason I say partially is because you'll remember, we basically pulled forward sort of a lot of the forecasting for the next couple of years of acuity as we got into the first quarter of 2023. So what we know now would push that number up, but there's also a counterbalance to that as we continue to perform well, especially in states with paybacks, where we're forecasting for 2023 sort of the calendar year of 2023 to be in paybacks to the tune of about $1.3 billion in Medicaid. That would be a counterbalance to that because states ultimately adjust the rates by looking at the pool of participants in Medicaid and their positioning in risk corridor payback. So it's sort of a stale number at this point, but those are two factors that would push and pull up that number.

I was wondering if you could quantify what the redetermination impact was in the quarter? And then if we're thinking about the sort of April and May cohort, especially April is coming up towards the end of their 90- to 120-day response period, and I know you guys only have a couple of states in that cohort. But could you talk a little bit about what sort of information you get? Do you know who is responding of your members? And have you gotten any information on what a success rate looks like for that April cohort?

Yes, Sarah, regarding the impact, we have seen a decrease of 263,000 members in Medicaid since March 31, 2023, which aligns with our expectations. When analyzing the monthly cohorts, we might observe a higher rate of members returning in April because we are a few months post the incurred month, whereas July may show a lower rate since members still have time to return. Currently, about 20% of the members who lost eligibility have regained their coverage, with 85% of those having experienced no break in coverage. The remaining 15% are being reinstated a month or two after losing eligibility. However, it's still early, and there has been limited redetermination activity in April. We will be watching closely in the coming months to observe how the reinstatement of members develops.

I have two questions for you. First, a couple of your competitors mentioned that their second quarter results were impacted by a non-negligible MLR headwind from the California court settlement related to COVID costs from a previous period. I’m curious if your quarter reflected that or if you had already accounted for it. Second, returning to Scott's question, I want to ask again about commercial MLR. Excluding the deductibility seasonality, in the first quarter, your commercial MLR was down 290, but this quarter, it’s up 350. A small portion of that is from SEP, and another small portion is related to the smaller year-over-year RAF accrual true-up. It seems to have deteriorated, but I understand you believe it’s in line and that you expect the year to still align with your commercial MLR expectations. I’d like to get a better understanding of the changes from Q1 to Q2 from your perspective.

Yes, we accounted for SB 510 in California during Q1 when that information became available. As we mentioned in the Q1 call, this is why our numbers were a bit higher at 90.0, and we had a strong performance in Q2. So far this year, our Medicaid results are looking good. Regarding commercial, Q2 '22 had positive dynamics, and we did not experience any insolvency issues from the '21 calendar year, which did not impact the final settlement from CMS like it has over the last five quarters, including this quarter. That has been a fluctuating factor. Our growth last year was impressive, and it remains strong this year. While this might put some short-term pressure on us, we are excited about our leading market position and the strength of the Ambetter brand. We are seeing significant growth this year, which will enhance our earnings capacity for 2024 and beyond. However, that is reflected in the current period, putting a slight strain on the HBR.

Just a clarification. In terms of the Medicaid retention rate, I know about 1/3 you expect to end up with. But in terms of timing, just given that we have these 90, 120-day sort of reenrollment windows, do you expect to land at that 1/3 number, I guess, second quarter of '24? Or is there going to be sort of a couple of month lag where maybe it will take another quarter before you end up planning that 1/3?

Part of that depends on whether people complete the process within that 14-month timeframe. It's difficult to predict what the situation will be by Q1 or Q2 of 2024. Therefore, it's challenging to determine exactly when each state will conclude. However, we believe that the numbers we provided represent the ultimate outcome, and that perspective hasn't changed.

And again, all those outreach efforts that I mentioned are designed to try to minimize the span between someone who's dropped eligibility, but is still eligible in the recapture. And that includes, obviously, the direct outreach, but also relying on primary care physicians and providers in general, so that we're not recapturing folks when they're showing up at an emergency department. And so I think that outreach has also proven to be successful, at least in these early months.

Maybe just to shift gears on the Medicare side for a moment, and your comments around the cost trends were definitely helpful. There's still a lot of different theories out there as to why Medicare is seeing elevated cost trend in '23 specifically, particularly in outpatient, while Medicaid and commercial are not really seeing the same elevated trends. So I was just curious to get your thoughts and any additional color on why you think this is happening in Medicare specifically this year?

Yes, I mean it's tough to speculate here and don't plan on it, but you could probably think about the composition of our members. 49% of our members in Medicaid are under 19 years old. So there's probably not a lot of cardiac, or ortho, or cataract, which is what we're seeing on the Medicare side. Other than that, I can't really explain other than saying what we're seeing in Medicaid and Marketplace is pretty stable relative to the pop we saw in May, which is not alarming, but figured it would be a helpful commentary for you guys, given some of the noise around the industry and the fact that our Medicare HBR was a little bit higher than we expected in the second quarter.

Just a couple of clarifications. Maybe just sticking on that last question. Drew, I'd be curious if you could maybe frame the magnitude of this kind of step down that you saw in June when you're thinking about kind of monthly cadence? And how you're expecting that to play out over the back half of the year? And then a quick follow-up on the Marketplace margins and expectations for next year. Given both the growth you're seeing, the SEP enrollment, as well as kind of pricing plans for '24, what type of margin improvement you'd expect to see in the commercial business next year just as we think about progression into '24?

Well, we definitely have priced for and expect margin progression as we get into 2024. We'll have to give you more of an update as we get towards the end of the year at Investor Day for more specific '24 guidance elements that detailed. And then on your '23 question related to trend, as Sarah said in her script, we've got accommodation in our at least $6.45 adjusted EPS guidance for some continuation of this. Although to your point, we did see a step down, not all the way back to April, but a step down in June and sort of that holding in July with respect to the relativity from what we saw with May incurred through their second month of development.

Thanks, Rocco, and thanks, everyone. We appreciate the interest and all the great questions. We look forward to providing additional updates on our progress as we move through the back half of '23. I hope you all have a great day.