Molina Healthcare Inc (MOH) — Q1 2020 Earnings Call Transcript

Good morning and thank you for joining Molina Healthcare's First Quarter 2020 Earnings Call. With me today are Molina's President and CEO, Joe Zubretsky; and our CFO, Tom Tran. Press releases announcing our first quarter earnings and the definitive agreement to acquire Magellan Complete Care were distributed yesterday after the market closed. Press releases and the slide presentation regarding the MCC announcement are available on our Investor Relations website. A replay of this call will be available shortly after the conclusion of the call for 30 days. The numbers to access the replay are in our earnings release. For those who listen to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today Friday, May 1, 2020, 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 first quarter 2020 press release. During our call, we will make forward-looking statements, including statements relating to our growth prospects, our 2020 guidance, the Magellan Complete Care acquisition 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 for the 2019 year 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 up the call and take your questions. I would now like to turn the call over to our Chief Executive Officer, Joe Zubretsky. Joe?

Thank you, Julie, and good morning. This is an unprecedented time. The COVID-19 pandemic has had and will continue to have a profound impact on our country, our state partners, our members, and our employees. Our team has worked tirelessly over the past two months to ensure that the needs of all of our constituencies are addressed quickly in this rapidly changing and challenging environment. COVID-19's impact on the U.S. healthcare system and the overall economy will continue to develop during the year, undoubtedly causing some short-term challenges, but also highlighting the important role government-sponsored healthcare plays in this type of crisis. Clearly, the macroeconomic environment will significantly impact our results this year and for the foreseeable future. With that said, as a pure-play government managed care business, we remain well-positioned at a time when reliable access to high-quality healthcare is more critical than ever to our members and our state partners. We would like to provide you with updates today on a number of fronts. First, we will cover the financial results for the first quarter. Second, we will discuss the new but hopefully temporary operating environment created by the COVID-19 pandemic. Third, we will convey our guidance in the context of our first quarter results and this new operating environment; and fourth and lastly, we will provide some detail about our exciting acquisition of Magellan Complete Care that we announced last evening and other updates to our pivot to growth initiatives. Let me start with specific first quarter highlights. We reported earnings per diluted share for the first quarter of $2.92, with net income of $178 million and an after-tax margin of 3.9%, which slightly exceeded our expectations for the quarter. Premium revenue was $4.3 billion, an 8.9% increase over the prior year, which is consistent with our pivot to growth. The medical care ratio was 86.3%. We experienced medical cost pressure in the Medicaid line of business early in the quarter, resulting from slightly higher-than-normal seasonal flu, combined with early, but at the time, unidentified COVID-19 costs. These increased costs were offset by lower medical costs in all lines of business very late in the quarter as elective and discretionary healthcare services began to be postponed and deferred. These offsetting factors, combined with negligible prior period reserve development, produced a medical care ratio that squarely met our expectations. We managed to a G&A ratio of 7%, in line with our expectations, even after reflecting incremental expenses associated with the mobilization of our workforce to work at home, and other new operational protocols related to COVID-19. The total company after-tax margin was 3.9%, in line with our expectations, comprising product line margins, of 3.2% in Medicaid, 8.4% in Medicare, and 4.1% in Marketplace. While a $2.92 earnings per share result modestly exceeded our expectations, its achievement is noteworthy in the context of the environment in which it was produced, which brings us to our second topic. The dramatically different environment in which we currently operate and some of the changes we have made in response, to recap a few of these measures. As shelter in place directives and all-out shutdowns quickly spread throughout our geographic footprint, we swiftly moved substantially all of our associates to work at home. We accomplished this with no disruption to service, as service metrics have remained excellent. This is a remarkable accomplishment in light of the potential for disruption to utilization management, care management, network access, and IT infrastructure. Substantially, all of our company's workforce, 10,000 associates, are currently working from home. Many providers have seen disruption to their patient and revenue flows. Providers are struggling more than ever with utilization management, payment integrity routines, and associated protocols in a rapidly evolving environment, where their cash flows have suddenly declined. While this requires adaptability on our end, we maintained strong performance in network management and utilization control. To assist providers in this challenging time, we accelerated claim payments by $150 million in late March and early April, while also extending the term of all non-COVID-19-related prior authorizations through September 1, 2020. We also increased Telehealth visit reimbursement to be at parity with in-person visits and have expedited credentialing to ensure we have ample provider capacity. We understand that COVID-19 creates a variety of challenges for our employees, including family members at home who may need support and children who require care. We quickly implemented broad-based programs to help them during this time, including two special stipends of $500 or a total of $1,000 for each of more than 9,000 of our employees. We also implemented pay enhancements for essential employees required to come to the workplace and an additional COVID-19 pay lead policy. We are responding to dozens, if not hundreds, of special requests by our state customers, CMS, and other governmental agencies. For example, we eliminated all member costs for COVID-19 testing and related treatments. We relaxed utilization management protocols in specific instances. We expanded Telemedicine access to all members and we made substantial contributions to the supply of personal protection equipment. We also committed support and resources for various nonprofit organizations serving those in need across the country. Support, supplies, and monetary donations have been made to a variety of trusted organizations that directly serve vulnerable populations. In summary, we would characterize our first quarter results as more than respectable, in the context of unprecedented disruption to the entire spectrum of traditional managed care operations that occurred over the span of just a few weeks. In this difficult operating environment, it should be noted that our financial position is strong as we had already done the hard work to develop very solid capital and liquidity positions. A few words about these matters. Our share repurchase program has now been completed as we purchased a total of 3.4 million shares in the quarter for approximately $450 million at attractive prices. We drew down $380 million on the remaining capacity of our term loan facility to bolster our liquidity. We utilized this inexpensive debt instrument, which would have otherwise expired in the coming quarter. And after the completion of the share repurchase program and the term loan facility draw, we are holding approximately $840 million in excess parent company cash. I'll turn now to our third topic, a discussion of our near-term outlook, starting with a description of the current dynamics of our industry. The business model, government managed care, particularly Medicaid, has been stress-tested through extreme economic scenarios, including the financial crisis, the subsequent boom, and now the effects of the world's worst pandemic in over 100 years. The model has proven to work in both robust economies and in deep recessions. In strong economic environments with low unemployment, there are relatively fewer Medicaid and subsidized Marketplace members, capitation rates tend to be on the strong side of actuarial soundness as state budgets are well funded. During challenging economic environments with high unemployment, there are relatively more Medicaid and subsidized Marketplace members, capitation rates tend to be on the lighter side of actuarial soundness as state budgets become tighter. So while government managed care, particularly Medicaid, is certainly impacted by this environment, the business and financial model flexes to accommodate these unusual and sometimes extreme circumstances. In an extreme environment, like the one we are in today, government intervention is often required to provide rescue packages, backstop the healthcare system, and the disadvantaged population. The current crisis is no exception, as Congress and the White House have stepped forward with a number of measures. The Families First Coronavirus Response Act includes additional assistance for state Medicaid programs in the form of an increase to the FMAP match. Each state has received a 6.2% increase, which will extend throughout the COVID-19 public health emergency declared by the Secretary of Health and Human Services. There have also been a number of legislative aid packages enacted, including the $2 trillion stimulus package and the additional $484 billion supplemental COVID-19 spending package referred to as Phase 3.5. These funds, in various forms, have been made available to providers, small businesses, individuals, and a number of other constituents which should ease the pressure on the healthcare system during this crisis, which indirectly should help the viability of Medicaid programs. In short, we have a stress-tested business model and significant government intervention designed to accelerate the economic recovery. But even in the presence of these very positive factors, which support a favorable outlook for the longer-term trajectory of the business, the near-term quarter-to-quarter outlook remains difficult to predict. This brings us to a discussion of our guidance for the remainder of 2020. Two overarching factors must be considered in providing guidance in this environment. First, we face a remarkably wide range of possible medical cost scenarios that could emerge over the next nine months. We have modeled many utilization scenarios for the balance of the year, all of which are plausible, but each of which produces dramatically different results. Second, we must consider the likelihood of a significant increase in membership as a direct result of widespread unemployment. With rising unemployment levels and the suspension of Medicaid eligibility redetermination in many states, we are now likely to experience a significant increase in combined Medicaid and Marketplace enrollment. But by how much? We do not yet know. These COVID-19 effects on medical cost and membership are widely expected to have a net positive effect on near-term earnings. However, we are not yet prepared to draw this conclusion based on the many variables and uncertainties that remain as managed care moves through the full course of the pandemic. We are, however, prepared to state that we view our original 2020 plan in our previously announced guidance with enhanced confidence. Accordingly, we are reaffirming our full year earnings per diluted share guidance range of $11.20 to $11.70. Let me briefly walk through the thought process that supports our guidance. With respect to medical costs, at this point, we cannot predict with any degree of precision how the COVID-19 situation will impact medical costs in 2020 for a variety of reasons. First, the level of future direct COVID-19-related costs is not yet estimable, as the incidence rate of diagnosis and hospital admission and the related cost per episode remain unclear. We observed a steep decline in elective medical procedures very late in the first quarter, through the month of April, but we do not know how long this phenomenon will persist and begin to normalize. The prevailing expectation is that discretionary utilization could be very low for the second quarter and perhaps beyond, but then rebound quickly in the second half as COVID-19 abates, and health system capacity frees up. And any potential short-term and nonrecurring benefit from lower utilization is partially limited by rebates we could be obligated to pay under applicable minimum MLR regulations. With respect to our administrative costs, our operating efficiencies are secure, and our operating leverage discipline is intact. There will continue to be G&A pressure, however, related to nonstandard operating protocols and the cost structure required to service any significant additional membership. Investment income will certainly be lower than our original forecast as money market and other maturing fixed-income investments grow over into much lower-yielding instruments. Our portfolio is short dated, so the impact is rather immediate. Before the onset of COVID-19, we fully expected to achieve our membership guidance. With the unfolding unemployment levels and suspension of Medicaid eligibility redetermination, we are now likely to exceed that guidance. But by how much? We do not yet know. We have developed various models and scenarios based on macro and microeconomic factors, which produce widely different results. The eventual outcome will be influenced by several key factors, including unemployment levels, particularly in the lower wage services economy, availability of spousal coverage and COBRA uptake. The impact of these factors is likely to be greater in the economically sensitive Medicaid expansion sector. Relatedly, pre-COVID, we fully expected to achieve our premium revenue forecast for the year of $17.4 billion. Our previous membership forecast was achievable, and our rates were generally known. Now it seems likely we could exceed our revenue forecast, depending on the timing and extent of the additional membership we just discussed. The YourCare acquisition will be an additional source of growth when closed. I also note again that any potential upside to annual earnings is limited by rebates we would be obligated to pay under applicable minimum MLR regulations. In addition to our compliance with such regulations, even if our MCRs come in lower than our own internal targets, with a mindfulness of our civic responsibilities, in order to address any unexpected imbalances, we could choose to reinvest some of that margin into provider-based quality of care initiatives and additional benefits for our members, here in the communities where they live. While the current near-term economic environment is unpredictable, government managed care business has consistently shown very attractive growth characteristics with compelling free cash flow generation. We are in the right business at the right time to serve our members, support our state partners and move with confidence and conviction into the future. However, we also believe that making accurate and perhaps bold statements about our longer-term future makes little sense at this time. Accordingly, we have decided to postpone our May 28 Investor Day and perhaps until later in the year. For now, we are strictly heads down doing the hard work we need to be doing. I turn now to the fourth and final area of commentary this morning, an update on the many activities relating to our pivot-to-growth strategy. Even with the extraordinary level of activity related to COVID-19, which is now our highest priority, we have not lost sight of our near-term focus on top-line growth. Opportunities to enhance and expand our portfolio in a substantial and synergistic way occur infrequently. Last night, we announced just such an achievement as we signed a definitive agreement to acquire Magellan Complete Care, or MCC, from Magellan Health. This transaction caps nearly a year-long effort, long predating the COVID-19 crisis and delivers compelling benefits that will endure for years to come. A single bolt-on acquisition, we add businesses in three new states and three overlapping states to our portfolio at a purchase price equal to approximately 30% of the target's revenue. Pro forma, the newly expanded Molina Healthcare will surpass the $20 billion mark in annual revenue. Let me briefly describe the businesses we purchased, their strategic fit with our portfolio, and the resulting financial metrics. As of December 31, 2019, MCC served approximately 155,000 members across six states: Virginia, Arizona, Massachusetts, New York, Florida, and Wisconsin. Full year 2019 revenue was greater than $2.7 billion, and we project it to grow to $3 billion within two years. Magellan Complete Care comprises the following businesses: Full-service Medicaid in Virginia, a new state; full-service Medicaid in Arizona, also a new state; dual eligibles and Massachusetts-branded senior whole health, again a new state; managed long-term care in New York Metro area, branded senior whole health, a new geography, and two small businesses, one in Florida and one in Wisconsin. The addition of the MCC properties allows us to apply our previously demonstrated operating excellence to bring these businesses to our target margins, harvest the full benefit of fixed cost leverage by adding more revenue with little additional fixed costs, and launch Medicare and Marketplace in new Medicaid geographies. Turning to the financial metrics, the $820 million transaction, net of certain tax benefits, is expected to close in the first quarter of 2021. The purchase is funded entirely with cash on hand. We project that it will deliver returns well in excess of our cost of capital as our demonstrated operating capabilities put us in a unique position to improve the margins of these businesses. As we move margins to our targets and deploy our enterprise-wide platforms to the benefit of fixed cost leverage, we expect the acquisition to be accretive by approximately $0.50 to $0.75 cash earnings per diluted share in the first year of ownership and accretive by at least $1.75 in cash earnings per diluted share in the second year of ownership. These new additions to our portfolio demonstrate how carefully targeted M&A can accelerate our pivot to growth. With the addition of MCC, we will serve more than 3.6 million members in government-sponsored healthcare programs in 18 states. We will achieve enhanced geographic diversity, greater depth in our portfolio, and a meaningful addition of durable top line revenue. We will also be able to maintain continuity of care for MCC's members and stability for its state partners. These qualitative considerations have added importance in the current environment and demonstrate our unwavering commitment to capably assist our government partners in bringing high-quality healthcare to individuals and families during this time of great need and into the future. Let me provide you with some additional highlights as it relates to our pivot-to-growth strategy. First, we terminated our agreement to purchase Next Level Health due to the seller's stated unwillingness to close pursuant to the terms of the acquisition agreement. Second, in New Mexico, all legislative and political hurdles have been passed in connection with the development of the first-ever Indian managed care entity. We have been named as the exclusive manager of the managed care entity with the Navajo Nation. We stand poised and ready to serve the 75,000 Navajos eligible for Medicaid. Third, as previously announced, Texas canceled all of the new contracts associated with the STAR+ reprocurement awards and canceled the STAR CHIP RFP. The state has commented that it is not likely to reprocure this contract in the near term. Thus, we expect that our revenue base on this contract is secure at least through 2021. Fourth, we await the decision by the state of Kentucky on its Medicaid RFP, which we expect to be issued before the end of the second quarter. While Tennessee is the only state to specifically announce that it is postponing its RFP due to COVID-19, we believe there will be a general tendency by other states to also delay procurements until the COVID-19 crisis has abated. Finally, in our continued efforts to shape our business portfolio to optimize value, we have decided to sell our Puerto Rico Medicaid business. In doing so, we will work closely with the regulatory authorities and the provider community to ensure that our members in Puerto Rico are not disrupted and have reliable continuity of care. Now for some concluding remarks. I hope it is clear to all that during this time, our members and customers will make requests of us to do the extraordinary. Our philosophy is to provide healthcare first and ask questions later. We trust that we will be adequately rewarded for the work we do and the services we provide. Although in this environment, we expect some nontraditional protocols to be invoked. This philosophy is not incongruent with shareholder friendliness at all. In fact, it is the epitome of a prudent environmental, social, and governance philosophy, and the pillar of long-term business sustainability. We will fulfill our moral, civic, and patriotic duty, and we will emerge from this an even stronger company. Not only are we proving to be flexible and adaptable in this changing environment, but we will ensure our performance during this challenge enhances our growing reputation among our existing customers and potential new customers alike, as a go-to resource in government-sponsored managed care. Before I turn the call over to Tom, I want to recognize our management team and the entire Molina community. During this unprecedented time, our team, 10,000 strong, has worked tirelessly to ensure that the needs of all of our constituencies continue to be addressed quickly and effectively. The true highlight of the quarter was the performance of our entire workforce and their rapid operational and clinical response across every dimension of the healthcare ecosystem; truly inspirational. They never lost sight of the members and the state partners who are counting on us to deliver whatever the challenge. Now I will turn the call over to Tom Tran for more detail on the financials.

Thank you, Joe. This morning, I am going to provide some details on our first quarter results, provide additional insight into COVID-19's impact on our medical costs, and then I will give more color on our 2020 guidance. So let me start with the quarter. Premium revenue for the first quarter of 2020 increased 8.9% to $4.3 billion compared to the first quarter of 2019, primarily due to rate increases in our Medicaid and Medicare lines of business. The consolidated MCR for the first quarter of 2020 increased to 86.3% compared to 85.3% for the first quarter of 2019. While prior year's reserve development in the first quarter of 2020 was negligible, the MCR in the first quarter of 2019 was positively impacted by approximately 140 basis points of favorable reserve development. The increase in the MCR in the first quarter of 2020 also reflects the increase in Marketplace MCR. Now for some details on our results by line of business. In the Medicaid business, the MCR in the quarter was 88.9% compared to 88.5% in the first quarter of 2019. Our Medicaid performance for the first quarter of 2020 was solid. As we continue to manage medical costs, harvest the benefits of our payment integrity and utilization management protocols and attain risk scores commensurate with the profiles of our members. Furthermore, the MCR in the prior year quarter was positively impacted by the aforementioned favorable reserve development. The impact of COVID-19 on medical costs in the first quarter of 2020 was not significant. We experienced medical cost pressure in the Medicaid line of business early in the quarter, resulting from slightly higher-than-normal seasonal flu combined with early but lastly undetected COVID-19 costs, diagnosed as severe respiratory illness and pneumonia. We also experienced increased pharmacy costs in the quarter as members refilled their chronic medications in advance of the height of the crisis. These increased costs were offset by lower medical care costs in all lines of business very late in the quarter, as elective and discretionary healthcare services began to be postponed and deferred. In the Medicare business, the MCR for the first quarter of 2020 was 81.7% compared to 84.7% in the first quarter of 2019, due to rate increases and higher quality incentive revenues. Finally, in the Marketplace business, the MCR for the first quarter of 2020 was 72.3% compared to 52.2% for the first quarter of 2019, which was mainly attributable to our lowering prices in 2020 in an effort to be more competitive. The G&A ratio for the first quarter of 2020 improved to 7% compared to 7.3% in the first quarter of 2019, primarily related to increased revenues and positive operating leverage. The G&A for the quarter reflects approximately $6 million of incremental expenses associated with the mobilization of our employees to work at home, along with other operational protocols associated with COVID-19. Now on to COVID. Let me offer some additional insights, but recognize that this picture is unfolding in real time. Some statistics, as we sit here today. Through April 27, we had a total of 950 members hospitalized with COVID-19; based on early data, the average length of stay is approximately 10 days, and there is no statistically credible cost per episode yet. In terms of geography, the health lands most impacted by COVID-19 are Washington, California, and Michigan. While Washington was the first state impacted, Michigan has experienced the highest number of cases. While many of our states are estimated to have peaked, some have not. In proportion to our membership by line of business, Medicare has the highest percentage of incidents, followed by Medicaid and then Marketplace. Lastly, we experienced a steep decline in elective medical procedures beginning very late in March, which has continued through the month of April. Turning now to our balance sheet and cash flow. Our reserve approach remains consistent with prior quarters, and our reserve position remains strong. Days in claim payable represents 49 days of medical cost expense compared to 50 days in the fourth quarter of 2019. Operating cash flow for the first quarter of 2020 was $136 million, with the change from the first quarter of 2019, primarily due to the timing of government payments and accelerated payments to providers. As of March 31, 2020, our health plans had total statutory capital and surplus of approximately $2 billion, which equates to approximately 347% of risk-based capital. Turning now to our 2020 guidance. We have reaffirmed our full year 2020 earnings guidance range of $11.20 to $11.70 per diluted share. First, let me walk through what is included in our full year guidance. Net investment income will experience headwinds due to lower yields. We factor this in our guidance, and we expect it to be approximately $0.27 per share of headwind for the full year. Incremental G&A expenses related to COVID-19 for the balance of 2020 have also been considered. Now let me walk through what is excluded from our full year guidance. We recognize that rising unemployment levels are likely to result in an increase in Medicaid and Marketplace enrollment. However, we do not know the magnitude or timing, and therefore, membership increases related to COVID-19 are excluded from our full year 2020 guidance. Due to the uncertainty of COVID-19's impact on utilization and medical costs, its impact on net medical costs is excluded from full year 2020 guidance. I will also note that our full year 2020 guidance does not include the impact from previously announced acquisitions that have not yet closed. While the timing, duration, and severity of COVID-19's impact on our financial metrics and earnings on an intra-quarter basis and throughout the rest of the year is not entirely predictable, we believe this is the most reasonable approach to providing guidance for the full year of 2020. This concludes our prepared remarks. Operator, we are now ready to take questions.

Thanks, good morning, Joe. Can you talk a little bit about the Magellan acquisition in terms of where you see margins along the trajectory of the accretion analysis? So where do you expect margins to be at the end of year one and year two to get to that accretion number?

Sure, Justin. Let me make sure I frame the deal first. This is right out of our playbook. And the way we think about this is this is sort of six bolt-on and tuck-in acquisitions all bundled into one. And as you know, what we've said many times, is we look for acquisitions that have stable membership, stable revenue flows and if they're underperforming, we certainly will bring to bear our operational excellence discipline and rigor in order to improve margins. So the way we look at this is you've seen the numbers. They are slightly profitable in the aggregate, approximately a 1% EBITDA margin. As you know, we've averaged about 6% or 6.5% EBITDA margins in the last couple of years. With the positive operating leverage, because we're not going to increase the fixed cost base of running our enterprise when we take these on, you can easily see how we got to the $0.50 to $0.75 of accretion in the first full year of ownership and at least $1.75 of cash earnings per share accretion in the second full year of ownership. So in the first year of ownership, we will most likely operate on their cost structure as integration activities take place. In year two, we will be migrating to the Molina cost structure, both our G&A platforms and the impact of payment integrity, utilization, management and risk or quality will begin to improve the medical cost ratios. And sometime in year three, we should reach the margins that we enjoy today in the moving of portfolio. Does that help?

Yes. That's really helpful, Joe. And then if I could just ask one more on cash. You talked about, I think, $840 million coming out of the quarter. Can you walk us through the moving parts for the rest of the year in terms of dividends from the subs, etc.? And where you expect to end the year from a cash perspective as well as a leverage perspective?

Sure, Justin. Well, yes, we ended the quarter with $840 million of free and clear cash at the parent company. If we achieve our earnings guidance for the year, we project that we will extract approximately $500 million of ordinary dividends from our operating subsidiaries. That could be higher if we're able to get extraordinary dividends. Bear in mind, we have a $500 million untapped revolver. In connection with this transaction, we topped up that revolver with a short-term facility of an additional $400 million. To recap, $840 million of cash, our projection of extracting at least $500 million of ordinary dividends during the balance of 2020 and then two untapped facilities which aggregate to $900 million of debt capacity. I'll also remind the group that our high-yield debt is trading really well right now. We believe we have really good access to the high-yield market if we wanted to make any of this financing permanent. So that's the cash flow story.

Hi, thanks. Good morning, everyone. First question, just wanted to ask on the MCC and clearly, there's a significant margin improvement opportunity. I think that is embedded in that deal for you. Interested in what you're thinking in terms of what you can do to also accelerate top line growth from the MCC assets as well. Specifically, maybe thinking about the three new states that you'll be entering. How could this potentially tap into additional business-line opportunities for you and then in some of the other tap-on products that you'll be adding from this?

Sure, Scott. There actually is an embedded growth rate in the acquired portfolio itself. The Arizona full-service Medicaid contract is at its very early stages. If I remember correctly, about 13,000 members at the end of the year with approximately $80 million in revenue. That's projected to achieve a membership of 75,000 to 80,000 over the next year. Because it enjoys a preferred position in the auto-assignment algorithm in the state. The second point you make is spot on. As you know, our strategy is to take our full product line and penetrate it into our Medicaid footprint. Now that we have a new Medicaid footprint in Arizona and in Virginia, we absolutely plan to launch a DSNP product and our Marketplace product in those geographies. Being in the boroughs in Westchester in New York City, gives us plenty of opportunities to look for other bolt-on opportunities and perhaps grow the business. As you know, right now, we're in upstate New York and don't have a product in downstate New York. But this gives us plenty of opportunity to think more broadly about how to participate in Metro New York.

Got it. And then just my follow-up question. I understand that you're just hesitant right now to build in anything on revenue or enrollment from rising unemployment. Just interested if you can maybe just give us a little insight into maybe what you've seen so far in April. Possibly in the Medicaid and the Marketplace exchange lines, especially given states relaxing redetermination reviews?

Sure. I'm going to break with tradition here a little bit. You tend not to talk about what's going on in the current quarter, but this is an unusual time. The points you mentioned are really, really important to pretend what could happen to membership. First, I would point to is before talking about April, for the first time in many, many quarters, maybe even since I got here, we actually had membership growth in Medicaid sequentially March 31 over the end of the year. Good growth in Washington, Michigan held steady, good growth in Illinois, offset by some losses in Puerto Rico. So our efforts to work with providers to keep more members in the system and bring on more members are pushed to make sure that in the redetermination and re-eligibility process, we hold on to more members is starting to work. Pushing that forward now to the direct question you asked, it's even looking better in April. Our Medicaid membership is likely to be up over 30,000 members just in the month of April. The interesting point I will make is we believe we are pretty sure that none of that membership arrived as a result of the accelerated surge in unemployment. It's too soon to see people that became unemployed in March end up in managed Medicaid. So we believe that the 30,000 growth in April is truly due to the suspension of eligibility determination in the states. Without that churn, you're just not going to lose the members. They stay longer, they stick longer. Many states have actually suspended redetermination, and some have even announced perhaps even for a full year. This really tends well for the membership growth before the surge due to unemployment actually arrived, which is likely to in May and beyond. Does that help?

Thanks. I was just wondering what you think the MLR might be on these new members coming into the Medicaid and to the exchange programs. I guess last recession we did see some heads up demand initially on the new Medicaid lives, and just thinking about whether you expect that to happen. And on the Medicaid side, if these patients are members or people who would have been on COBRA, do you expect any adverse MLR there?

Yes, we have various views on it. I mean, I think basically, you could generally say that if somebody needs insurance, they buy it. If they don't, they won't. So there's just sort of an inherent bias, adverse selection bias in the whole process. We have various scenarios, some of which might say that there's higher acuity coming in through membership and some say that it will be on par with what we have. It's hard to say where the number is coming from. Are they coming from a very rich self-insured plan and a big company? Or are they coming from a small group plan for a small business? So it's really hard to say right now, which is obviously one of the reasons why we're reluctant to predict what this surge in membership brings. We'll see a surge in membership. We have to build the operational platforms and hire the people to service that membership. As you suggested, the acuity of that membership is unknown. The prevailing wisdom is, while it might be slightly better or worse than the average, that's not going to be a significant factor in taking on these members.

All right. Great. And then when I look at your guidance, you're excluding a number of things from your guidance, but I see that pretty much all of them are the things that are most positive than they are to be negative. Is there anything negative really, I guess, that is not included in guidance or has the potential to be a significant negative?

If I understand your question correctly, the two factors that we updated in our guidance are one that's sort of easy to understand. Our portfolio is going to roll over into lower-yielding investments. It's irrefutable and already happening. I think Tom pitched that as a $0.27 headwind in our guidance. We also believe putting the accelerated membership aside that we will incur higher SG&A related to COVID operational protocols, financial assistance to our employees, etc., which also we factored into our reaffirmation of our guidance, but we did not update for anything else.

Hi, good morning. I had two quick questions. The first one, I just want to go back to, Joe, your comments about Medicaid MLRs? I know there's also some states with pre-tax caps, but sort of the curves on how low MLR could effectively go and flow through earnings. So certainly, we understand that those exist. I guess the question is, on a state basis, are those all typically just calculated on the state fiscal or calendar year? There's no rolling period like there are in some of the federal minimum MLR requirements.

Yes, Gary, that's my understanding. There are very few adjustments, like in the Marketplace MLR where taxes and all these other factors create a dramatic difference between the regulatory minimum and what you publish in your financials. Seven of our 14 states have some form of MLR floor, ranging from 85% to 86%, except Puerto Rico, which is 92%. Those also exist in the expansion population and exist in the ABD business, usually at different rates. There are very few adjustments from what you publish, and the minimum. By my understanding, they work on a one-year fiscal year basis, not a rolling basis.

And my second question is you talked about 950 members hospitalized with COVID-19, no statistically credible cost per case. So I guess two questions. One, are those provider revenue cycle claim submissions being materially delayed? And then secondly, I thought most of your contracts in Medicaid would pay on a DRG basis. Are you saying you're just not seeing the DRG coding yet? Or is there enough complexity to sort of outlier payments on outlier length of stay cases that dedicating all that still doesn't give you a good sense of the numbers yet?

No, it's actually not that complicated. Again, 1,000 cases, so you can't draw any statistical credibility to that. We have five-day stays, and we have one-month stays. We have people in the ICU on ventilators and people that go in and go out. Costs range from $10,000 per episode to $100,000 per episode. But we're now capturing all the codes. What Tom was suggesting in his prepared remarks is that early in the quarter we were getting tagged with all types of respiratory elements, particularly in Washington and California. This was before COVID was a phenomenon. In hindsight and better information now, we have attributed that, and it has been attributed to COVID-19 actually showing up in Washington and California far before anybody thought it was. But no, there's no intrigue around how we're getting billed and coded for these things. With only 1,000 data points, it's hard to draw any statistical conclusions. Regarding your other point, we are not seeing any dramatic change in the administrative aspects of our provider dealings. We are seeing a drop in pre-authorizations and claim submissions just because of the elective procedure deferrals. But there has not been a huge disruption in either the level of payments and the level of submissions that we've observed to date, that could change here over the next couple of months.

Yes, sir. Thank you. I was hoping you might comment on how you're thinking about the changes in enrollment trajectory over time. I realize that probably a number of scenarios you're looking at for how this recession plays out. But for lack of a better metric, do you think comparing with sort of duration and gap for 2008, 2009, is the broad side of the barn?

Sure. Well, Matt, many of you have seen all of the different pundits and think tanks project what this might look like, with unemployment scenarios ranging from 10%, 20%, even up to 30% with Medicaid rolls expanding anywhere from 10 million to 30 million members. A very wide range of results. I think, as we mentioned in our prepared remarks, there are lots of factors to consider here. Number one, COBRA used to be a rather significant factor in how many members would come in. Now with subsidized Marketplace, you could argue that there will be more members attracted to the subsidized Marketplace, which might be the 102% of premium that COBRA charges. Even on the unemployment rate, we need to look at subsectors of the economy. We're looking at the lower wage service economy. I believe that's not going to come back quickly. The sandwich shop, the dry-cleaner shop, that coffee shop, these small businesses are going to struggle to get back to business. We think that the lower-wage service economy will have higher unemployment rates for a longer period than perhaps the higher-wage sector of the economy. Thus, if you take our market share, if you do a projection of unemployment in all of our states, ranging from 10% to 20%, look at our market shares. In Washington, it's 50%. In most states, it ranges from 5% to 25%, 9% on average. You can craft a scenario where the membership peaks at a pretty significant number. As unemployment softens, some of that goes back, but I think there's a permanent delta here on that lower-end service economy that's going to struggle to get back into business quickly.

Yes, that brings up a very closely related question, which is, again, we're shooting in the dark here. But would you predict we might see some structural changes in how healthcare coverage is handled at the small group and particularly the lower end of the small group, maybe lower wage end of the spectrum, given it's been volatile for a while, and now it's even more volatile?

It's a good question. I say during all the swirl and the activity around this, I hadn't given that much thought. But the way we look at it is we now do have a product suite that works all the way up to 400% of federal poverty level. When you think about it. So when we have Medicaid expansion in a variety of states, up to 138, then we have a highly subsidized Marketplace up to the 200, 250 range. We have products that the population can buy up to that level. I hadn't given your specific question a lot of thought during all this, but I will do so and get back to you on that.

Your line is live. Perhaps, your line is muted. Sorry about that. Sorry I was on mute. Question around the exchanges. And I know it's early, but sort of April application processes and things that are coming in. I'm just trying to get a sense of as individuals move from the commercial markets into whether it's Medicaid or Marketplace. Where do you think the magnitude of impact is going to be? Is there any data that you're seeing on Marketplace applications to date that would be helpful?

Right. We are seeing, I'd say, at this early stage, given that April data I was speaking about, we haven't seen Marketplace growth yet. But we have seen a slowing in the natural attrition rate. As we said at the beginning of the year when we gave our Marketplace forecast, we have reduced our attrition rate outlook to 1%, 1.5% a month. Which would suggest 3,000 to 4,500 members that is slowing. We believe membership will start growing again here very soon. The point I was making before, I think, is the important one. COBRA charges 102% of the full premium. We believe, based on all the models we've looked at, that a highly or even reasonably sized subsidy in the Marketplace products, silver product, let's say, beats 102% of commercial all the time. We think it's going to be the net beneficiary of folks who come out of commercial plans and find that highly subsidized Marketplace product beats staying on COBRA.

And Joe, just to follow-up on that point. Is it fair to assume that I know you talked about some of the adverse selection bias in processes like this where people buy insurance if they need it. But in this situation, isn't it fair to assume that those remaining on COBRA are going to be ones that are more focused on continuity of care and have chronic needs and things like that? Are you assuming that the Marketplace membership may actually have a positive bias?

That's an excellent point. Generally speaking, if you're in the middle of some kind of expensive treatment protocol or a chronic member on expensive drugs, you just don't move because you're happy with what you have. COBRA has unlimited life, and those members have to go somewhere eventually. Right now, we're not assuming anything other than we're building the infrastructure to make sure we can handle the influx of members. Jason Dees, who runs our Marketplace business, is very mindful of how we capture risk scores and risk profiles in these members. We know when we get them how to treat them, how to get them into care plans, etc. So very early stages. I don't have any more thought on it than what I just gave you.

And just one quick call on the revenue guidance, is there an assumption of pass-through revenues that are going to be coming through? Or is that in the bucket of COVID impact that we're not anticipating?

I'm not sure I understand. Are you referring to Medicaid? I'm not sure what you're referring to, exactly, Josh.

Yes, Medicaid payments where you're going to see increases to the provider fee schedule they get passed through in terms of Medicaid.

I think it's possible. I will answer the question more broadly. Most of our state customers are very concerned with the viability of various aspects of the medical communities in their states. Whether it's going to be enhancements to the fee schedule requests, as you've seen, to pay claims faster, in some cases, even advanced payments to small providers, they are very focused on the health of the provider system. But we have not seen yet, based on what I've been exposed to, any major changes to fee schedules. But there are many conversations ongoing about how to keep the providers funded during this entire process.

Thank you. I wanted to circle back to your comments that in a strong economy, Medicaid rates are set at the high end of actuarial soundness and in the recession, will be set at the low side. Can you give us more detail on what that means for meaningful margins when you think about the peak to trough move?

I think the first thing I would say, Sarah, is we put a lot of faith in the concept of actuarial soundness. There are ebbs and flows. There's constant tension when benefits are carved in, when the benefits are carved out, and when new populations are attempted to be capitated. There's a constant ebb and flow. And the only point we are making is that from a business model perspective, you would expect that in very strong economies when tax revenues are flowing, rates would be on the strong side of actual soundness, and the opposite could be true when tax revenues are down, in terms of recession. The concept of actuarial soundness has proven in this industry. It's proven in the years that I've been here as testament to the margins that we're achieving. There are ebbs and flows. All I'm suggesting is that in a recession, we could expect rates to be on the softer side of the actuarial soundness concept. We still have not changed our outlook for our target margins, but a lot needs to be seen here in terms of what trend figures are going to be baked into the 2021 rates. Are we going to use normalized trends off of 2019? The bigger issue is when trends are inflecting the way it is, how are the actuarial teams and our state customers going to reconcile the various views of medical cost trend when we go to look at 2021 rates. But all that being said, I have a lot of faith and confidence in the actuarial soundness concept because it's actually worked well for managed Medicaid.

That's very helpful and comforting given how strong the relationship is with the state actuaries as medical trend does change. So just one more follow-up there. You mentioned that one of the possibilities could be items being carved in and carved out. Can you provide us any color on your discussions with states on how they're viewing the shape of their program, given where their budgets may be?

Sure. The one aspect of managed care and medical cost in managed care that comes to mind in your specific question is related to pharmacy. As you know, that is commonly discussed as to be either carved in or carved out. You probably saw in the New York state budgetary process that was just finalized. They have suggested that at some point in the future, New York State could carve out pharmacy. Obviously, not terribly material for us with a $200 million business there, but carving in and carving out is actually, in my view, more of a question of how much rate must be put in or taken out. We'd rather see it bundled into the full capitation and have more revenue. But if it's carved out, if they carve out on an unsubsidized basis, you lose your 2% margin on what's carved out, and that's it. You just hope through the negotiating process that the proper amount of capitated rate is either carved in or carved out. That's the issue, in my opinion.

Yeah, good morning, guys, and thanks for taking the questions a lot been covered. A lot has been covered. I guess, Joe, kind of a follow-up on the Magellan deals. As you think about the M&A environment, do you expect kind of the current environment that we're going into now to make M&A more difficult or less difficult? Trying to figure out if people are targeting Medicaid enrollment to defend smaller businesses and smaller plans, making them harder to acquire? Or could people see this as an opportunity to exit? I have a quick follow-up for Tom.

Interesting question. I think most of the investment banking community would tell you that in the past couple of weeks or months, many in-flight processes have stalled. This one's been going on for some time. It was able to get done with great cooperation from the guys from Magellan, and the teams worked well together. It's hard to say. I think this business is tough. We look at some of the smaller players, the not for profits, the single-state players, it's hard to get the operating leverage, the scale, the clinical resources you need to actually do a good job. It's just a tough business. But when this is all you do, and you have 3.5 million members and $20 billion of revenue, we certainly have the investable base, the skills, and the resources to be well here. So buying underperforming properties at 30% of revenue, getting the EBITDA margins up to 6%, 6.5%, that is a great use of our resources and our skills. Particularly when they're funded with cash that is generated from core operations, and we don't have to go to the equity markets or even the debt markets to fund them. So here in the foreseeable future. Obviously, we're going to be working on the regulatory process with Magellan, then we'll be integrating it. But we're still going to look for these single-area, bolt-on, tuck-in opportunities like the YourCare acquisition, which is fabulous for us. We're going to continue to look for them because we have the cash flow to action on them if they're actionable.

That's helpful. And I guess, Tom, my quick follow-up for you is an accounting one, which is I know it's early, but if we start to think about the contracts where you guys have MLR minimums. I imagine at some point you'll have to reserve against revenue or have contra revenue accounts for what could be premium rebates or premium holidays. Have you guys started to do that yet? Is it too early to think about or discuss what the magnitude of that could look like?

Good question there. We do that consistently every quarter. As you know, in our marketplace, we have to provide reserve for potential rebate based on certain forecasting of the eventual medical care ratio. We do the same thing for our Medicare line of business. We will be doing the same thing for Medicaid should that happen to be the situation.

Hi, good morning. Thanks for taking my questions. Joe, you always have the great ability to cut right to the chase. My question is around operating Medicaid managed care organizations in a COVID environment, thinking about a couple of transactions you now have in flight that include New York operations at the center of COVID. Just interested in understanding how you might see the future change in one's ability, the risks, and opportunities in managing a plan in a cohort affected environment given that you seem willing to step right into the epicenter with both of these acquisitions, YourCare and MCC having significant operations in New York.

Thanks for the question. It's a challenge. We moved 6,000 people from working in office to working at home. There are, as I said, hundreds of requests we're getting from regulators every day to do certain things. That requires you to have to reconfigure your provider contracts. The operational change and the amount of operational change that we’re going through to deal with all this is significant. In New York, our business is in upstate New York, which is not the epicenter of COVID, but certainly is being impacted. The MLTSS business in New York is a good business. We managed $2 billion of LTSS benefits nationwide. I think we're the largest or the second-largest manager of LTSS benefits. It fits nicely with the portfolio. It's not a medical business, per se. It's a business where we cater to the activities of daily living to pretty complex members under the Medicaid program. But it's a good business. It's got over $700 million in revenue. It's reasonably profitable. We believe we can enhance profitability by managing the hours more effectively. COVID-19 was certainly a consideration as we actioned it. But we're either COVID-19 will have abated by the time we own it or be so well understood and well managed that it will be the new normal. So it was a consideration, but it did not deter us from wanting that property and including it in the purchase.