Molina Healthcare Inc (MOH) — Q3 2025 Earnings Call Transcript

Good morning, and welcome to Molina Healthcare's Third Quarter 2025 Earnings Call. Joining me today are Molina's President and CEO, Joe Zubretsky; and our CFO, Mark Keim. A press release announcing our third quarter 2025 earnings was distributed after the market close yesterday and is available on our Investor Relations website. Shortly after the conclusion of this call, a replay will be available for 30 days. The numbers to access the replay are in the earnings release. For those of you who listen to the rebroadcast of this presentation, we remind you that all of the remarks are made as of today, Thursday, October 23, 2025, and have not been updated subsequent to the initial earnings call. On 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 the third quarter 2025 earnings release. During the call, we will be making certain forward-looking statements, including, but not limited to, statements regarding our 2025 guidance, our preliminary 2026 outlook, the medical cost trend and our projected MCRs, Medicaid rate adjustments and updates, our 2026 marketplace pricing and rate filings, our RFP awards, including our contract wins in Georgia and Texas as well as our M&A pipeline and activity, revenue growth related to RFP wins and M&A activity. The recently enacted Big Beautiful Bill and expected Medicaid, Medicare, and Marketplace program changes, our expected future growth in both our existing footprint and in the new products and markets and the estimated amount of our embedded earnings power. Listeners are cautioned that all of our forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from our current expectations. We advise listeners to review the risk factors discussed in our Form 10-K annual report filed with the SEC as well as our risk factors listed in our Form 10-Q and Form 8-K filings with the SEC. After the completion of our prepared remarks, we will open the call to take your questions. I will now turn the call over to our Chief Executive Officer, Joe Zubretsky. Joe?

Thank you, Jeff, and good morning. Today, we will provide you with updates on our reported financial results for the third quarter, an update on our full year 2025 guidance, our outlook for 2026 and our growth initiatives. Let me start with our third quarter performance. Last night, we reported adjusted earnings per share of $1.84 on $10.8 billion of premium revenue, below our expectations. Our 92.6% consolidated MCR reflects the continuation of a very challenging medical cost environment in the third quarter. We produced an adjusted pretax margin of 1%. The headline for the quarter is that approximately half of our underperformance is driven by the Marketplace business and that Medicaid, while experiencing some pressure, is still producing strong margins. Year-to-date, our consolidated MCR is 90.8%, and our adjusted pretax margin is 2.7%. In Medicaid, our flagship business representing 75% of our total premium revenue, we reported an MCR of 92% and an adjusted pretax margin of 2.6%. Medical cost trend was higher than expected and driven by utilization of behavioral health, pharmacy, LTSS, and inpatient care, largely consistent with what we observed throughout the year. A few positive rate updates were not enough to offset the elevated trend, and our risk corridor protection is now very limited. While our Medicaid performance did not meet our expectations for the quarter, many would characterize these results as best-in-class in this environment. In Medicare, we reported a third quarter MCR of 93.6%. We continue to experience higher utilization in this high acuity population, particularly related to LTSS and high-cost drugs. In Marketplace, the third quarter MCR at 95.6% was significantly higher than expected. We continue to experience much higher utilization relative to risk adjustment revenue. Our third quarter adjusted G&A ratio of 6.3% was very strong, reflecting our continued operating discipline. Turning now to our 2025 guidance. Our full year premium revenue increases to approximately $42.5 billion. Our full year 2025 adjusted earnings per share guidance is now expected to be approximately $14 per share, which is $5 below our prior guidance of $19 per share. This revised guidance reflects a consolidated MCR of 91.3% and a pretax margin of 2.1%. As we recount our original EPS guidance of $24.50 and a $10.50 revision to $14, we note that half of this revision emerges from the unprecedented utilization trend in Marketplace, which represents nearly 10% of our business. Only one-third emerges from the rate and trend imbalance in Medicaid, which is 75% of our business, and the remainder for Medicare. Now, some color on the segments related to our revised guidance. In Medicaid, our guidance assumes a full year MCR of 91.5%, which produces a pretax margin of 3.2%. This Medicaid MCR result is above the high end of our long-term target range, but we evaluate it in the context of this challenging trend environment. Average rates achieved are now expected to be 5.5%, but medical cost trend for the year is now expected to be 7%, which is 100 basis points higher than previous guidance. Our early 2025 rate increases were sufficient at the beginning of the year. But as medical cost trend increases beyond those rates, our MCR increased each quarter. The rate updates we received later in the year and risk corridors did not provide an adequate buffer. In Medicare, our full year guidance includes an MCR of 91.3% and pretax margin is at breakeven. We continue to effectively manage elevated utilization through our cost control protocols. In Marketplace, the full year guidance MCR of 89.7% produces a negative pretax margin. We expect higher utilization to persist as in past quarters with little to no risk adjustment revenue offset. Our Marketplace business has significantly underperformed our expectations, but its performance appears consistent with industry-wide trends. As noted a moment ago, approximately half the earnings per share reduction from initial guidance and prior guidance is attributable to this business, which represents just 10% of our consolidated revenue. Marketplace was initially projected to produce over $3 of earnings per share, but is now expected to produce a loss of $2 per share, a swing of over $5 of the $10.50 reduction from our initial 2025 guidance. Our updated full year guidance at $14 per share implies earnings per share of approximately $0.35 in the fourth quarter. Within this fourth quarter EPS guidance, Medicaid is projected to earn $3 per share with a 92.5% MCR and a pretax margin of approximately 2.5%. Medicare and Marketplace are expected to offset the Medicaid performance with a combined $2.65 loss per share. The fourth quarter and second half projected Medicaid performance provides a strong jump-off point for our 2026 outlook. Now some commentary on our outlook for 2026. While it is far too early to provide formal guidance, we believe a discussion of the 2026 building blocks for both revenue and earnings per share will be helpful. I will lay out the components and Mark will provide further details. Our 2026 premium revenue outlook anticipates growth in our current footprint, consistent with historical levels, significant new Medicaid contracts in Georgia and Texas, and Medicare duals growth in 5 states through our recent RFP wins and MMP conversions. These items alone would put us on track to meet our target of $46 billion of revenue in 2026. However, our 2026 pricing strategy for Marketplace, with the intention and expectation of reducing our exposure will likely be a revenue headwind, although earnings accretive. With respect to our outlook for 2026 earnings per share, there are several items to consider, particularly related to the Medicaid earnings baseline. First, our Medicaid performance in the second half of 2025 is expected to produce a 92.3% MCR and a 2.5% pretax margin. This equates to $6.50 per share in the second half, the annualization of which is an appropriate jumping off point for 2026. Second, we note that there is normal rate-related seasonality pressure in Medicaid in the second half of the year. Third, with some early views of our January rate cycle, which comprises 60% of our full year revenue, we project rates will be modestly in excess of trend. And Medicare and Marketplace are projected to at least break even, although we are driving to achieve our target margins. This early view of the 2026 earnings per share baseline should provide for an outlook for 2026, which likely approximates this year's updated full year guidance. However, we further note the following areas of potential upside to this baseline view. Medicaid rates, as every 100 basis points of improvement produces an additional $4.50 per share, performing better than breakeven in Medicare and Marketplace as we continue to target low to mid-single-digit pretax margins, and harvesting a portion of our $8.65 of embedded earnings. At a high level, that is our outlook for 2026. Mark will take you through more detail on this in a moment. Finally, turning to our growth initiatives. Despite the short-term margin challenges, we continue to fuel our growth engines and see a clear path to surpass the $50 billion premium revenue mark in the next few years. During the third quarter, we continued our successful track record of winning RFPs with the renewal of our Wisconsin My Choice contract in Regions 2 and 7. We are engaged in active RFPs in several states and have an active pipeline of $54 billion of new opportunities over the next few years. On the M&A side, our acquisition pipeline contains a growing number of actionable opportunities. This current challenging operating environment has been a catalyst for many smaller and less diverse health plans to consider their strategic options. We remain opportunistic in deploying capital to accretive acquisitions. In this temporary period of rate and trend imbalance, we are going to work to acquire as much Medicaid revenue as possible and, as we have done in the past, work it up to target margins. At our last Investor Day, we characterized this environment as inclement weather rather than climate change, metaphorically meaning temporary rather than permanent. We continue to believe this to be true. Medicaid is expected to produce a 3.2% pretax margin and contribute approximately $16 per share this year. Rates will come back into balance with medical cost trend and the business will recalibrate to target margins. Medicare is experiencing a rejuvenation aimed at serving the very attractive dual eligible segment, which we believe is poised for significant profitable growth. And Marketplace is undergoing a rationalization, addition by subtraction as we reduce our exposure while the risk pool stabilizes. In short, these businesses are well positioned for long-term and sustainable profitable growth. With that, I will turn the call over to Mark for some additional color on the financials. Mark?

Thanks, Joe, and good morning, everyone. Today, I'll discuss some additional details on our third quarter performance, the balance sheet, our 2025 guidance, and the building blocks of our 2026 outlook. Beginning with our third quarter results. For the quarter, we reported approximately $11 billion in total revenue and $10.8 billion of premium revenue with adjusted EPS of $1.84. Our third quarter consolidated MCR was 92.6%, reflecting a continued challenging medical trend environment for each of our segments, but was moderated by our consistently effective medical cost management. Half the miss versus our expectations this quarter was due to the significant underperformance in Marketplace. In Medicaid, our third quarter MCR was 92%, higher than our expectations. We continue to experience medical cost pressure across many cost categories, particularly for behavioral, pharmacy, and LTSS. The combination of these trends exceeded rate updates received throughout the year. In Medicare, our third quarter MCR was 93.6%, also higher than our expectations. We experienced higher utilization among our high-acuity duals populations, particularly for LTSS and high-cost pharmacy drugs. In Marketplace, our third quarter reported MCR was 95.6%. Utilization in our membership was significantly elevated compared to our prior guidance. In past years, higher trends have often been offset by risk adjustment benefits. However, since Marketplace risk adjustment is relative to the market, not absolute like Medicare, the higher trend this year across the entire national population mitigates the risk adjustment offset we would have expected to realize. Our adjusted G&A ratio for the quarter was 6.3%, reflecting our normal operating discipline. I will note that our effective tax rate in the third quarter dropped significantly, reflecting benefits related to acquired federal tax credits and the impact of lower nondeductible expenses. Turning to the balance sheet. Our capital foundation remains strong. While margins are lower than our targets, I point out that positive earnings continued to add to our capital base and drive cash flow via dividends to the parent. In the quarter, we harvested approximately $278 million of subsidiary dividends, and our parent company cash balance was approximately $108 million at the end of the quarter. RBC ratios, which test the level of capital at the subsidiary level compared to regulatory requirements, are 340% in aggregate and unchanged since the end of 2024. Total subsidiary capital is 70% above state minimums. Our operating cash flow for the first 9 months of 2025 was an outflow of $237 million due to the settlement of Medicaid risk corridors and Marketplace risk transfer payments as well as the timing of tax payments and government receivables that offset the normal positive items. In the quarter, we have repurchased approximately 2.8 million shares at a cost of $500 million. We see real value in our shares at current market prices, which we believe at this low point in the rate cycle underappreciate the longer-term margin targets of our business. Debt balances at the end of the quarter increased temporarily to fund the share repurchase. Current ratios are 2.5x trailing 12-month EBITDA, and our debt-to-cap ratio is about 48%. We continue to have ample cash and access to capital to fuel our growth initiatives and execute on our capital allocation priorities. Turning to reserves. Days in claims payable at the end of the quarter was 46. We remain confident in the strength and consistency of our actuarial process and our reserve position even in this period of sustaining high trend. Next, a few comments on our 2025 guidance. Our full year premium revenue guidance is slightly higher at $42.5 billion. Our adjusted earnings are now expected to be approximately $14 per share. Within our guidance, the full year consolidated MCR increases to 91.3%, up 110 basis points from our prior guidance. Updated EPS guidance is $5 below our prior guidance of $19 per share, reflecting our higher full year MCR outlook. The medical margin decline of $6.25 in our guidance is partially offset by $1.25 of favorable G&A and the modest impact of lower average share count. I will note that Marketplace, which comprises just 10% of our total revenue, contributes half of that medical margin-driven EPS shortfall. In Medicaid, we expect fourth quarter MCR of 92.5% and full year now at 91.5%. This full year outlook is up 60 basis points from our prior guidance, reflecting the third quarter experience and our expectations for higher trend in the fourth quarter. Within those numbers, our full year Medicaid trend rises from 6% to 7%. Updates in several states increased our full year rate outlook from 5% to 5.5%. We continue to see a willingness from states to discuss off-cycle and retro rate adjustments as data develops, but we do not include speculative updates in our guidance. Even in this challenging operating environment, our Medicaid segment's full year pretax guidance margin is 3.2, and implied second half margin is 2.5, demonstrating the underlying strength and execution of our main business. In Medicare, we expect fourth quarter MCR of 93.6%, in line with the third quarter. Our guidance for the full year of Medicare MCR rises to 91.3%, a 130 basis point increase from our prior guidance, mainly driven by expectation for full year trend rising from about 4 to 5. The Medicare segment full year pretax guidance margin is breakeven. In Marketplace, we expect fourth quarter MCR of 96.2% and full year at 89.7%. Within our marketplace guidance, full year trend rises from about 11 to 15. We expect the full year G&A ratio to be approximately 6.5%. Due to third quarter share repurchases, our fourth quarter share count falls to 50.9 million, and full year is 53 million. Finally, I'll expand on Joe's comments on our initial outlook for 2026. While we're unable to give guidance at this early stage, I would like to further detail our initial views on the premium and EPS building blocks for 2026, which may help shape your perspectives and modeling. A number of known items put us on track to meet our target of $46 billion of revenue in 2026. They include normal growth in our current footprint, the new Medicaid contract wins in Georgia and Texas, and the Medicare duals growth in 5 states as our MMPs transition to FIDEs and HIDEs. However, we anticipate 2 revenue headwinds in 2026, which we are unable to size at this early stage. First, given the lapse of enhanced tax credits or subsidies in Marketplace and the significant uncertainty will cause in the risk pool, we are repricing the Marketplace book of business to reduce exposure and restore margins. Our 2026 rate increases averaged 30%, ranging from 15% to 45%, and we have exited difficult geographies. I will note that for the next year, we have reduced our county footprint by 20%, and our #1 and #2 price position is going from 50% of our footprint in 2025 to an estimated 10% of our footprint in 2026. Separately, we may see a small impact to Medicaid membership due to the recently passed budget bill, but continue to expect most of that impact will manifest in 2027 and 2028. I'll now run through a similar set of building blocks on the EPS side. As a baseline for 2026, our Medicaid performance in the second half of 2025 is expected to produce a 92.3% MCR, a 2.5% pretax margin, and contributes $6.50 per share to earnings. We annualize that to $13 per share for full year Medicaid baseline for 2026. Next, we adjust that baseline upward to reflect normal seasonality pressure in the second half of the year. Remember, second half MLR is typically 50 basis points higher for seasonal items in our rate cycle, which implies a 25 basis point increase to next year's annualized outlook from the second half of 2025. Then early views of draft rates in our January rate cycle, which comprises 60% of our full year revenue, now suggest next year's full year rates could be better than an initial proxy for trend by 50 basis points. While still short of the significant catch-up needed in rates more generally, our early data points suggest states are moving in the right direction. Next, we anticipate increased G&A expense next year as a return to normal compensation expense levels are only slightly offset by the end of the unusual implementation expenses we recognized in 2025. Lastly, we expect the benefit of lower share count next year to be largely offset by the impact of declining interest rate environment on our interest income. These building blocks will enable a fair outlook for 2026 that likely approximates for this year's updated full year guidance. I will note that this approach inherently assumes that both Medicare and Marketplace are earnings neutral next year. As we build our plan for next year, we see additional potential upsides in 3 areas. Most significantly, we remain optimistic on the margin improvement potential as state-set rates for 2026. Many state programs are underfunded as we are now in the sixth consecutive quarter of abnormally high medical cost trend. Published reports and our own internal analysis suggest that the market needs 300 to 500 basis points of rate in excess of trend to breakeven. States are listening, becoming more responsive and weighing more heavily on recent medical claims data in the rate-setting process. We have very strong rate advocacy efforts working with our state partners to restore rates to appropriate levels. Rate increases beyond our initial assumptions create significant earnings upside as each 100 basis points of MLR yields $4.50 of earnings per share. Separately, as noted, this 2026 outlook also conservatively assumes Medicare and Marketplace will break even. In Medicare, we remain strategically focused on our dual eligible population and improving pretax margins. Each 100 basis points of MLR yields $0.80 of earnings per share. In Marketplace, any positive margins are also upside to our building blocks even on declining revenues. A final source of upside is our embedded earnings, which accounts for the estimated accretion from new contract wins and recent acquisitions. We will harvest some portion of the $8.65 per share in 2026. This concludes our prepared remarks. Operator, we are now ready to take questions.

Can you elaborate on the drivers of ACA MLR pressure in the quarter? It sounds like there was a negative surprise in the September Wakely data; can you confirm and quantify that for us? And given the timing of the ACA pressure, how confident are you that this most recent utilization and morbidity experience was captured in your 2026 pricing?

I'll frame the answer and then hand it to Mark for more detail. The pressure in the quarter was strictly related to increased medical cost trend, literally across all categories. We have a higher percentage of special enrollment membership, which usually runs hot initially. It's all medical cost trends. The risk adjustment was not a factor in our trajectory of earnings per share. Now for next year, as Mark mentioned in his comments, we don't like to allocate capital to a product in an unstable risk pool. That's why we kept this small, silver and stable at 10% of revenue. So next year, our rate increases state-by-state range from 15% to 45%. They average 30%. We reduced our footprint by 20%, and more importantly than the raw price increase that went into the market is where does your product price sit compared to the other market participants. We were #1 or #2 silver in 50% of our markets last year. And this year, an early read, we don't have all the information, suggests that we're only going to be priced #1 or #2 in 10% of our core markets. Mark, anything to add?

Joe, I think that's well summarized. Just to hit that in the third quarter, a number of drivers because certainly, our MLR is up a lot Q3 over Q2 to your question. In general, it's the same trend pressure that every one of our segments are seeing. Joe mentioned SEP volumes keep coming. Program integrity, the different forms of membership attrition that come out certainly put a little pressure on it. What you'll also see, and I expect you to ask about this, is in our IBNR roll forward, you'll see some development that went back to last year on some large dollar items and some provider claim settlements. So you put those items all together, it certainly is the driver of a lot of pressure here in the third quarter on marketplace. Joe hit the key theme for next year exactly. We'll reduce our exposure significantly next year. We're not as competitive in most markets. We're pretty far down the rankings on most prices, which means I think we have enough price in there to jump over any unforeseens in the third and fourth quarters and, more importantly, minimize exposure next year.

That initial 2026 outlook only assumed on a reduced revenue base that would get Marketplace back to breakeven. But in our pricing, we certainly targeted mid-single-digit pretax margins.

Just a couple of clarifications on how you're thinking about Medicaid going into next year. In terms of the rates that you're discussing, are you then expecting rates to be in excess of this 7% cost trend that you're seeing right now? And then when you speak to enrollment trends, on one hand, it sounded like you talked to some level of normal enrollment growth, but then also talking about some expected pressure on enrollment. I guess could you just clarify whether you're expecting on a same contract basis in Medicaid for next year, whether enrollment is going to be up, down, or stable?

I'll answer the second question first. In each of the last 3 quarters, we saw a 1% membership decline in Medicaid, and that's just due to more rigorous and disciplined enrollment activities in each of our states. Now as you know, stayers versus leavers, that usually adds a little bit of acuity shift, which is probably part of the issue of why medical cost trend is increasing. But your first question about rates, there are 4 reasons why we're optimistic that rates will at least keep pace with the trend and probably be slightly in excess of trend. One is in the past, over the past year, states have been very responsive, on-cycle, off-cycle, retroactive, and prospective responding to the increased trend. Two, this cost inflection started in mid-'24 through mid-'25. We have a full year baseline that includes significant cost increases that can be rated for. So the updated baseline gives us optimism if that's included in the rate projections, then it captures a lot of the cost increase. Third, 3 of the cost categories that are increasing pressure on our results, LTSS, pharmacy, and behavioral are discrete rating cells in the rating process, very visible, very prominent, giving you great visibility into those cost components, and they can be rated for adequately. And lastly, an early glimpse, a very early glimpse, at the 1/1 cycle where 60% of our revenue renews gives us some optimism that rates will be slightly ahead of trend and including rate updates for the full year in 2026, be slightly in excess of trend. Mark, did I miss anything?

No, Joe, I think it's well summarized. Stephen, it's indisputable that managed Medicaid rates are 300 to 400 basis points underfunded, and our state partners are recognizing that. We understand there's budget pressures out there. But with the development of data, as Joe mentioned, that's indisputable. And our early outlook for next year is that rates will be at least somewhat better than expected trend. But as you can imagine, we're feeling our way through both of those right now, and we'll have more as guidance develops.

I appreciate the early comments about next year. Considering what you’re assuming on the public exchanges, there are numerous scenarios currently being evaluated regarding subsidies and enhanced subsidies. How does that influence your assumptions about breakeven? Additionally, how much variability could there be depending on the different outcomes this could lead to?

Well, we gave you the rate increases ranging from 15% to 45% averaging 30%. And I won't go through the discrete components. I'll describe them qualitatively. You were underwater this year. We're going to have a 3% negative margin so you put in a catch-up to get you back to target margins. You put in an estimate of trend, which we believe is very conservative. And then, of course, you have to estimate the impact of the acuity shift as the membership growth reduces due to the enhanced subsidy expiration. We believe we conservatively priced for all three of those elements. But again, the more important point is where does the product sit on the shelf compared to your competitors. And the fact that it's not #1 or #2 in most of our markets gives us a view that volume will be reduced next year. I can't tell you how much right now, but it will be reduced. And our assumption is that on that reduced volume, we can at least get this back to breakeven. But those conservative pricing assumptions did target mid-single-digit margins. Anything to add, Mark?

The only thing to add, A.J., is right now, we're priced for the expiration of subsidies, which is the base case on the table. I think inherent in your question might be, well, what if the rules on subsidies change? If the rules on subsidies change, then pricing changes as well. Our objective, as Joe said, would be the same, which is to break even or be better. But if the outlook and the regulation on subsidies change, then the rates need to change as well.

When you look at that early view of 2026 being similar to the $14 this year, would you characterize that as a new baseline from which you grow and realize your embedded earnings going forward? Or do you view that as abnormally depressed still and we should expect above-average growth for a couple of years as margins get back to targets in all three segments?

Whether we're taking the full year of 2025 in Medicaid at $16 or an annualization of the second half at $13, with the items of upside we mentioned, we certainly believe that rates will come back into balance with medical cost trend over time. Now the question everybody asks is, well, how much time will that take? We don't know, and we're not forecasting that. But next year, we are assuming that rates are in excess of trend, modestly in excess of trend, and that's a good jumping-off point. But we do believe we have not changed our long-term outlook on the margins for this business. In the first half of the year, we had a 3.8% pretax margin. And even that was below our long-term target of about 4.5% for the business. We believe, over time, these things come back to target margins. The market in Medicaid needs 300 to 500 basis points to break even, just to break even. We've consistently operated 200 to 300 basis points better than the competitors in all of our markets. We only need a fraction of what the market needs in order to get back to target margins. Mark?

And Josh, just to build on that, I noticed overnight, some of you did the math on our initial outlook, the building blocks to $14, and a few of you got pretty close. It sort of implies next year that the whole company would run about a 2% pretax margin and maybe a 2.5% on Medicaid, which, in both cases, is significantly below our longer outlook of 4% to 5% pretax for the whole company or 4.5% at the midpoint. So it certainly implies that next year, margins are reduced with a lot of growth potential as this rate cycle normalizes.

I would like to know your expectations for next year's exchange revenue, considering the various factors you mentioned in comparison to the $4.5 billion run rate this year. Additionally, you mentioned that SG&A might face some pressure year-over-year due to returning bonuses. Can you share your thoughts on how you believe the SG&A ratio will change year-over-year?

I'll answer the exchange revenue question first and kick it to Mark for the G&A color. We have various scenarios. And of course, what you're doing is you're looking at your price position versus the price positions of other players and looking at your competitive position and trying to forecast how much volume will you keep and how much volume will you get. We don't believe we'll get a lot of new membership, but we believe we'll hold on to some renewal membership. We have scenarios that indicate that revenue could come down from $4 billion to $2 billion or even slightly less than that at $1.5 billion. In either case, we are 100% comfortable of at least breaking even in that line of business next year. But our pricing models, even at that reduced volume, were priced to produce mid-single-digit target margins. Mark, do you want to take the G&A question?

Yes, Joe, just to build on the marketplace one, a lot of the consensus views out there are that Marketplace could shrink nationally 30% to 50% next year. I think what Joe is suggesting is it wouldn't be out of line to think we would as well with some of the numbers Joe mentioned. On the G&A ratio, we'll probably come in at a 6.5% this year within our guidance. That is low for the reasons you mentioned, compensation and a few other items, probably targeting roughly about a 6.8-ish is the right way to go for next year, at least to start your modeling.

On another point on the G&A question is really important because when we talk about target margins in Medicaid, one of the facts that is usually missed is that we operate just north of a 5% G&A ratio in that line of business, which we believe is best-in-class. So if we get 200 to 300 basis points of rates, which is equal to $4.50 a share and continue to operate just north of 5% on the G&A line in Medicaid, then we're well on our way back to target margins.

I appreciate that your guidance focuses on potential areas for upside, but it seems the market is more concerned about possible downsides. Some competitors believe that margins could decline next year instead of seeing slight improvements in Medicaid. The exchanges remain uncertain. I would like to hear your perspective on where you see the risks to the numbers. You mentioned this year, trends matched rates, but trends worsened as the year progressed. I'm unsure why you are confident that rates will remain slightly above as you suggested, by the end of the year. Regarding your comment about embedded earnings, with the business underperforming, how should we approach this? In the past, you've discussed the timeline for realizing embedded earnings—has that been extended by a year? How should we consider that aspect?

Regarding the margin and MCR questions in Medicaid, achieving a 91% MCR in the first half of the year and 92% in the second half, with an average of 91.5% and pretax margins at 3.2%, prompts consideration of what constitutes a low point. These margins are indeed at their lowest since we initially had margins of 4.5% to 5%. When drawing comparisons to others, it's important to recognize where we began, as we were previously two hundred basis points into the corridors. This positioning helped mitigate some of the medical cost pressure that began mid-2024. We are operating as planned and believe we will return to our target margins and re-enter the corridors. I also shared our preliminary outlook on rates, which incorporates recent state rate updates along with the anticipated cost changes. The Medicaid sector, which generates 75% of our revenue and reported a 3.2% pretax margin this year, is expected to keep performing well. While any business faces potential downsides due to medical cost trends, which are currently at 7% for Medicaid, 5% for Medicare, and 15% for the Marketplace, the focus remains on where these trends stabilize by 2026. The current demand in doctors' offices and hospitals suggests that capacity will eventually normalize, potentially stabilizing the overall cost trends, which are up significantly compared to two years ago.

Yes, Kevin, regarding the second part of your question about embedded earnings, we currently have $8.65. This figure represents earnings above what we are guiding for this year and includes earnings expected in future years. Previously, we indicated that we anticipate about one-third of this would convert into earnings in 2026. We're not prepared to provide a more exact figure at this moment, but we will offer guidance after the fourth quarter. It's important to note that within the $8.65, we accounted for $1 of implementation costs that impacted our earnings in 2025, which will no longer be an issue. This was related to the preparation for the FIDEs and HIDEs, which will begin on January 1. That headwind will be eliminated next year. There was also a minor component related to a $0.40 loss from the Virginia contract ending, which will no longer be a factor. So, next year, you effectively gain the dollar while recognizing the $0.40 headwind from Virginia, resulting in a net increase of at least $0.60 from secured earnings. We will provide further updates as we gain better insight into rate trends for next year, but some portion of the $8.65 will materialize.

The only thing I would add is embedded earnings is what we call an ultimate concept, meaning that you get to your ultimate target margins over a period of time. Now given where margins have settled recently, could that then take longer to get to ultimate? Sure. But we have not changed our view of the ultimate target margins in those businesses, but the timing of emergence is certainly something we'll update you on when we give 2026 guidance in February.

Let's shift our focus back to Medicare for a moment. Can you provide a breakdown of this year's performance, specifically between the traditional MOH D-SNP focused business and the acquisition of the Bright assets in California? How have each of these components contributed to this year's results? Additionally, as we look toward next year, how do these two areas impact your perspective on Medicare in relation to your breakeven margin outlook for next year?

Well, I’ll start off and then pass it to Mark. The Medicare business is currently experiencing a renewal, primarily focused on the dual eligible segment. With the Managed Medicaid Plans, we have $2 billion in revenue and 44,000 members transitioning to FIDEs and HIDEs, positioning us strongly, especially following developments in Illinois, Ohio, and Michigan as well as the D-SNP RFP process. Looking at the year-on-year comparison, this will be the third full year since acquiring Bright, which initially operated at a low margin, but we are working on improving that. As we convert these 44,000 members, plus adding 20,000 through service area expansion and MMP conversions, we are approaching this cautiously. The members are the same and in the same regions, but they are under a different product framework. Thus, we are being careful about the margins associated with this product. We anticipate breakeven performance; Bright typically improves in its third year of ownership, yet we remain cautious regarding the profitability of the MMP conversions until we gain a full year of experience. Mark, do you want to add anything?

Joe, that's well summarized. Within our $6 billion of Medicare, it's about one-third MAPD, about one-third MNP, and about one-third D-SNP. As we look to next year, those MMPs will translate to FIDEs and HIDEs given all of the RFPs that we won, so I think you'll see slight margin erosion as you go from MMPs into FIDEs and HIDEs, and that's one, just us being cautious about a new product; and two, recognizing that the second half of the year was hotter than we thought this year. That slight margin erosion, though, I think is offset as on the MAPD side, Bright ConnectiCare come back up to closer to where they should be on target margin. You put that all together, we're starting off at least margin neutral for next year.

On the M&A pipeline, since Investor Day last year, you spent a fair amount of time talking about the opportunities you see with smaller and regional players. And I think we've heard a fair amount of commentary across the space about potentially negative margins in Medicaid. And to contrast that with the significant share repurchase done in the quarter, can you just talk through how you're thinking about capital allocation priorities from here, capacity, and how developed that pipeline is in the coming quarters?

Sure. Our capital priorities have not changed. The order priority, organic growth, inorganic growth, and returning capital to shareholders through share repurchase, that haven't changed, and we have ample capital, as Mark said, we're still producing earnings. You throw leverage on top of earnings. We're producing $1.5 billion of capital capacity a year even at these compressed margins. On the M&A pipeline, if you look at our history of purchasing, what, $11 billion of revenue over 7 or 8 deals and only acting capital equal to 22% of purchase revenue, half of which is regulatory capital, hard capital we barely paid any goodwill value for the acquisitions. In this period of cyclically low margins, we're going to be very disciplined about prices paid for revenue streams. If you can buy a revenue stream from a struggling local health plan at or about book value, it's just as good as winning a new contract, no goodwill capital. All the capital was hard capital and regulatory capital. So the number of local not-for-profit health plans in Medicaid that have experienced prolonged operating difficulties and therefore profitability and capital problems has been a catalyst for the pipeline being replenished in very full, very full of actionable opportunities. And if you can action them at or around book value is as good or even better than winning a new contract. Mark, anything on capital allocation?

On capital allocation, Joe mentioned the prioritization, we always prefer to grow organically. But these M&A situations, when you buy them so close to book, almost feel organic. If the industry is 300 to 400 basis points underfunded, you can imagine some of these smaller players are starting to really struggle, which is why we feel good about the opportunities to do some M&A here and drive additional value from that perspective. On the capital side, we remain in a really good spot with our financial ratios. And again, with the earnings power of the business, even at these lower levels, we just continue to build book value and therefore debt capacity. So we feel pretty good about one, the opportunities, and two, our capital position.

Great. I appreciate all the details for 2026. It sounds like you see states moving in the right direction in terms of rates. But I'm wondering, is there any other type of relief that states are offering just above and beyond. Joe, I think in the second quarter call you said utilization management was constrained in certain states and more sort of allowable services. Are you seeing any signaling from states this could change over time?

What you’re describing relates to how the program is structured. States are under budget pressures and have several options available, including changing the program, reducing benefits, or altering eligibility requirements. Other companies have mentioned similar experiences, and we have noticed some isolated pauses in utilization, mainly concerning behavioral aspects. Typically, when utilization is paused on any cost component, expenses tend to increase. Most states are returning to full utilization protocols now, but this isn’t a widespread issue. We’ve seen some slight reductions in the size of programs and benefit changes in certain areas, but nothing significant. Looking toward next year, changes to program structure aren’t expected to play a major role in our outlook for 2026. These changes are sporadic and not a primary factor. Another aspect to consider is that states are taking enrollment processes more seriously, even before implementing work requirements, leading to a roughly 1% decline in membership each quarter for the past three quarters. Those who leave usually have a lower medical cost ratio than those who remain. Therefore, while there’s some pressure due to shifts in acuity, the main factor in Medicaid remains higher utilization among those who stay, not the shifts from those who leave. Ongoing program integrity is another issue observed on a state-by-state basis.

Just a bigger picture question on the exchange business in light of just the uncertainties, whether it's subsidies or otherwise the lack of visibility sometimes across that business. And you're taking a conservative approach, but I guess, can you talk about your overall commitment to that business, how you think about that? And at what point would your thinking change on that front in terms of your priorities and the overall mix of your business?

Thank you for the question. We will invest in the business as long as we believe the risk pool will remain stable. Looking back at the last five years, insurtechs have entered the market with unsustainable pricing, opened up eligibility for special enrollment, and introduced enhanced subsidies. If you examine membership duration and churn rates, you'll see the need for risk adjustment. If a member stays with us for 18 months, we don't receive risk adjustment. Given the inherent volatility of our portfolio, our capital strategy is to minimize investment in unstable risk pools. However, we have not discontinued the product; it remains available in over 300 counties. If we determine that the risk pool stabilizes over time, we can increase our investment and utilize our broker relationships. While others may view this product as essential, we see it as optional. We believe it may not be in demand next year, but once it moves closer to being viable, we'll take action.

Great. Just a couple of clarifications on Medicaid and Marketplace. For the '26 assumptions on trend and rate, are you kind of presuming that rates, given visibility you've got thus far are going to improve up to that trend level? Or do you think that trend level is going to be normalizing down? Could you also talk a little bit about the variability you see contract-to-contract or state to state in your margin performance? And does that present any opportunities for exiting any particular contracts? Or are they all doing comparably well? And then the last question is just on Marketplace. If you're seeing any sort of pull forward in activity , kind of the uncertainty in the membership there, if they're going to have the program going into next year for some of them. And if you could quantify that?

Mark, do you want to take the Medicaid rate question, the 2026 rate question, the state-by-state question?

Absolutely. Lance, on the Medicaid rates versus trend, again, the industry is 300 to 400 basis points underfunded right now. And while states might have budget pressures and be reluctant to completely address that, it's inevitable they need to. And so our view into early next year and what we're seeing from our state partners is that the trend in rate imbalance can't perpetuate. We're far enough into at least 6 quarters into it, that the trailing data is catching up with it. And our assumption is that extremely high trends as we've seen don't continue that they moderate somewhat. But more importantly, that states are recognizing with the trailing data that they need to catch up. It may take them many quarters to catch up, but they are starting to recognize that and catch up. And remember, if the industry is 300 to 400 basis points underfunded, the stat filings show that Molina is still performing 200 to 250 basis points better than the industry. So we need half of what the broader industry needs to get to our target margins, and the probability of us getting that half sooner than later is probably better than the whole market coming back to stasis. So we feel that some catch-up is appropriate and warranted, and we're expecting, again, a small catch up in our initial outlook here.

Mark and I have been focused on managing our portfolio closely, ensuring that everyone performs. There are cycles where performance can fluctuate, but every property we manage exceeds its cost of capital. There’s a misconception that smaller plans struggle to scale. We operate both $5 billion and $500 million health plans, and their margins aren’t tied to their size. We can be profitable even in the smaller plans because our shared services operate efficiently at an enterprise level. While state performance varies, we have no plans to downsize our portfolio. We’re targeting $54 billion in new opportunities over the coming years and have two major RFPs underway. Currently, we are expanding our portfolio without any concerns about underperformance in our operations.

I have a question about Medicare. Mark, when I consider your portfolio in Medicare, I recall you mentioning the long-term services and supports as well as the duals penetration. It seems like you have a high proportion of duals in a relatively ill population, which is why I was surprised by the extent of the medical loss ratio miss this quarter. Can you explain the variable consumption you've observed in the Medicare sector? What factors are contributing to this? I believe that members who are seriously ill tend to consistently utilize care, so I'd like to understand what is influencing the marginal cost of care in Medicare.

I think you have a variety of things going on. We typically talk about LTSS as being a bigger driver in a high acuity population, and it's certainly a built-in big part of each of these high acuity and duals products. And then on the high-cost drug side, that continues to be a factor across all of our businesses, but with certain cancer treatments with certain other therapies that are out there, high-cost drugs continued to be a very big driver of it.

And you make an interesting point. That in highly chronic populations, by definition, ABD and Medicaid and Duals, you wouldn't expect to see a cost inflection because they're using services from day 1 to day 365. And but we have seen it. And those are the two cost components in Medicare, LTSS hours and SNF admits and high-cost drugs, which are our Rx trends as a company are about 16% and 36% in the top 10 therapeutic categories. So they're being used across all our populations, and that is what's putting the cost pressure in Medicare. Even though they're already high acuity chronic populations, utilization is up.

With regard to Medicaid margins and state rate increases, I understand you're strongly advocating for better rate alignment. So I'm wondering how many of your states are actually reflecting recent '25 trends into the reference look back period for the upcoming January rates. Curious because in our conversations with state actuaries, it seems like actuaries at best can only consider a look-back period of 12 to 24 months, just given how difficult it is to shorten it, just given they need a few months ahead of time to submit to CMS for approval, need roughly half a year to run the process, and then clean 12-month look back that reflects about 3 months of claims runoff. So I'm curious, are you seeing states who actually reflecting '25 trends? And also on the Medicaid member attrition this year. I was wondering if you could quickly elaborate on the nature of that disenrollment. How many of these lives are rolling off because of procedural or administrative reasons? Just trying to better understand if this might be emblematic at the higher level of outsized procedural disenrollment that we've been seeing?

On the Medicaid rates, and Mark and I, particularly Mark spent a lot of time in this process. The data through June of 2025 is virtually complete. Yes, actuaries like to see data very well seasoned. And this cost inflection did start in mid-'24. So whether they use '24 but include early '25 as a trend factor or use mid-'24, '25 as the baseline and late '25 as a trend factor. As long as they capture the medical cost inflection either in the baseline or trend, we believe we'll be in good shape. So I'm not going to go state by state. The industry's advocacy efforts to fully consider the latest experience are very strong, and we believe are working. Whether the actual baseline period is 12 months older and then they include a generous trend on top of it or more recent period and less generous trend, it mathematically doesn't matter. But we are confident that the latest cost information either in the baseline or in a trend assumption is being contemplated in rates. Mark?

And Joe, that's a big point that isn't always well understood. If the look-back period is 6 months or 12 months ago, sure, that makes a difference from one perspective, but that's not the rate you get. The rate you get is that look back starting point plus a fair trend on top of it. Now actuaries can argue over what that fair trend is on top of it. But if that fair trend comes out at an appropriate place, the specific data, the look-back period is less relevant.

On your membership question, yes, states have just gotten more disciplined on eligibility requirements, and there's no one state or one area, about 1% per quarter for the last 3. And I believe in the membership decline in Virginia must be in there as of June 30. So the loss of Virginia, I don't have the number in front of me. Mark might have it. That also accounted for some of the membership loss. That contract rolled off a few months ago.

Right? And in the third quarter, 120,000 of our Medicaid members fell off due to the termination of Virginia.