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Good morning, and welcome to Molina Healthcare's Third Quarter 2025 Earnings Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jeffrey Geyer, Vice President, Investor Relations at Molina Healthcare. Please go ahead.

Good morning, and welcome to the Molina Healthcare's Third Quarter 2025 Earnings Call. Joining me today are Molina's President and CEO, 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%. Some color on the quarter. 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 1/3 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 increase 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. That at a high level 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 in balance, 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 the 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 goes 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 annualized 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 approximate 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 suggests that the market needs 300 to 500 basis points of rate in excess of trend to breakeven. States are listing, 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.

[Operator Instructions] The first question comes from Andrew Mok with Barclays.

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.

The next question comes from Stephen Baxter with Wells Fargo.

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 the 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, prospective and 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, gives you great visibility into those cost components, and they can be rated for adequately. And lastly, an early glimpse, 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.

The next question comes from A.J. Rice with UBS.

I appreciate the early comments about next year. Thinking about what you're assuming on the public exchanges, there are a lot of different scenarios on the table now with respect to subsidies, enhanced subsidies, et cetera. How does that affect -- what have you assumed embedded in the comment about breakeven? And how much of a variability might there be depending on the various ways this could play out?

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 reduce due to the enhanced subsidy expiration. We believe we conservatively priced for all those 3 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 changes, then the rates need to change as well.

The next question comes from Josh Raskin with Nephron Research.

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 3 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 ask 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.

The next question comes from Justin Lake with Wolfe Research.

I was hoping I could get you to share where you think exchange revenue would be for next year, given all those moving parts you talked about versus kind of the $4.5 billion run rate this year. And then maybe you talked about SG&A be a little pressured year-over-year given bonuses returning. Can you -- anything you could share with us in terms of where you think that SG&A ratio will shake out 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 the -- 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 5% of a G&A ratio in that line of business, which we believe is best-in-class. So if we get 200 to 300 basis -- 100 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.

The next question comes from Kevin Fischbeck with Bank of America.

Great. I guess I appreciate with the guidance that you basically are only signaling potential areas of upside. It really seems like the market is much more focused on potential areas of downside. You have some peers who are thinking that margins trough next year rather than are slightly better in Medicaid. Obviously, the exchanges are unknown. So I would just love to hear your view on where you think the downside risk to the numbers are. You said that this year, trends matched -- rates matched trend, but then trend got worse as the year went on. It's not clear to me why you have confidence that today, when you say rates look like they're going to be slightly above, why you'd have confidence that by the end of the year, that would still be the case. And then with your embedded earnings comment with, I guess, the business underperforming, how do we think about the embedded earnings? I guess, in the past, you've kind of talked about the trajectory of realizing them. Is that all pushed out a year? Like how should we be thinking about that part of the equation?

Well, on the margin question or the MCR question in Medicaid, when you produce a 91% MCR in the first half of the year, 92% in the second, averaging 91.5% and your pretax margins at 3.2%. It depends what you mean at trough from. I mean these are the lowest point of our margins because we started at 4.5% to 5%. So I think we have to -- when comparing our results to others, you have to look at the starting point. We started at 4.5% to 5%. It was just a year ago, we were 200 basis points into the corridors. One of the reasons why the cost inflection that began in mid-2024 didn't hit us as much is we were 200 basis points into the corridors late in '24, which buffered a lot of that medical cost pressure. So we're operating the way we want to operate. We believe we'll get back to target margins and even back into the corridors. And we're -- I articulated the early view of rates to our items, past state rate updates, the '24/'25 baseline already including a lot of the cost inflection, 3 rating components that are very discrete and highly prominent and an early glimpse at 1/1/26. So we think the Medicaid business, which is the earnings back to the company, 75% of our revenue, producing a 3.2% pretax margin at $16 a share this year is going to continue to perform. Is there downside? Any business has downside on medical cost trends. And there's no question that in all of our businesses with a 7% cost trend in Medicaid, a 5% cost trend in Medicare and a 15% cost trend in Marketplace, it's all about cost trend and where that settles in, in 2026. But our view is the appointment logs are filled in doctors' offices, the beds are filled in the hospitals. And at some point in time, capacity has to level out and trend levels out on this highly increased cost base. If trend just levels, costs are still up 15%, 20% of where they were 2 years ago.

Yes, Kevin, the second part of your question was on embedded earnings. As we said in our prepared remarks, we've got $8.65 now. And remember what that is, that's earnings on top of what we're currently guiding to in the current year, things that will emerge in future years. We're at $8.65. We had previously signaled we thought about 1/3 would come out into earnings in 2026. We're not ready to give a more specific number. Joe and I certainly will when we give guidance after the fourth quarter. But what you can think about is within that $8.65, remember, we were carrying $1 of implementation costs, which depressed our earnings in 2025. That just goes away. That was the preparation for the FIDEs and HIDEs. We'll kick those into gear January 1. So that kind of headwind goes away for next year. The other small component was we were expecting a little bit of a loss on -- from the Virginia contract going away. That was a $0.40 item. So that falls out. So you get the dollar next year. You have to recognize the $0.40 headwind from Virginia, but net, you're up at least $0.60 just on things that are money in the bank. The rest we'll update as Joe and I have a better view on trend in rates next year, but you'll get some portion of that $8.65.

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.

[Operator Instructions] The next question comes from Scott Fidel and Goldman Sachs. Please go ahead.

Maybe switching over -- let's switch back over to Medicare a little bit. And interested maybe if you can sort of break down for us around the performance for this year, sort of breaking it down between, let's say, the traditional MOH sort of D-SNP focused book of business. And then the acquisition of the bright assets in California and how each of those sort of have built into the performance this year. And that then looking out to next year as well how each of those 2 categories influence your view on Medicare into that, I think, sort of breakeven margin view that you have for next year?

Well, I'll tee it up, and I'll hand it to Mark. The Medicare business, as I said in my prepared remarks, is sort of going through a rejuvenation, and that is because it is -- it was always aimed at the dual eligible segment. But now with the MMPs, the $2 billion, 44,000 members, $2 billion of revenue converting to FIDEs and HIDEs, we're really well positioned, particularly with the swipe of Illinois, Ohio and Michigan and the D-SNP RFP process. So as we look year-over-year, this year versus next, the Bright acquisition will be what, the third full year of ownership, and that was coming from a very low margin position, we're building it up. That will provide some improvement. But as we convert these 44,000 members and by the way, add 20,000 due to the service area expansion and the MMP conversions, we're being a little cautious. They're the same members. They're in the same geographies, but it is a different product chassis. So we're being a little cautious with the margins in that product. So breakeven to breakeven, Bright does better in the third year of ownership, and we're a little bit cautious on the profitability of the MMP conversions until we have 1 year of experience. Mark, do you want to add anything?

Joe, that's well summarized. Within our $6 billion of Medicare, it's about 1/3 MAPD, about 1/3 MNP and about 1/3 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.

The next question comes from John Stansel with JPMorgan.

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.

The next question comes from Ryan Langston with TD. Cowen.

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?

With, I think what you're describing is the construction of the program. Look, states are pressured on budgets. They have a variety of things they can do. They can change the program, reduce benefits, reduce eligibility. And we've heard other companies talk about this. We've seen this at the margin. Have there been utilization pauses called by various states? Yes, isolated, mostly on behavioral. And what do you think happens when you pause utilization on any component of cost that goes up. Most states are going back to full utilization protocols at this point, but it's not a major phenomenon. Benefit changes, meaning reduction in the size of the program to the benefit changes. We've seen those on the margin in various places, but not significant. So going into next year, program changes, program construction is really not a major phenomenon to consider as we -- in our outlook for 2026. It's here, it's there, it's isolated, but it's not a major driver. Now the other component that we are seeing, as I mentioned before, and it shouldn't be ignored, is states even before work requirements are taking enrollment processes more seriously, and we've lost about 1% of membership per quarter for each of the last 3. Leavers usually have a lower MCR than stayers. So they're putting a little bit of pressure due to an acuity shift, but most of the pressure in Medicaid is higher utilization by the stayers, not the acuity shift by the leavers, but continued program integrity is another phenomenon that were experienced state by state.

The next question comes from Erin Wright with Morgan Stanley.

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.

As I mentioned previously, thanks for the question. We will allocate capital to the business as long as we are convinced that the risk pool will continue to be stable. And I look over the past 5 years, insurtechs coming in with unreasonable pricing, expanding the eligibility for special enrollment, enhanced subsidies in enhanced subsidies out. I mean you can go back and look at duration of membership, fast-churn membership, you need risk adjustment, you have a member for 18 months, you don't get risk adjustment. So when you look at the inherent what I call inherent volatility of the book, we have no choice in my -- in our capital philosophy of allocating as little capital to an unstable risk pool as we can. However, we did not pull the product. The product is available. It's available in over 300 counties. It's on the shelf. And if we come to the conclusion that the risk pool stabilizes for a period of time, we can allocate more capital, leverage our broker relationships. And while other market participants might consider this product a necessity, we consider it an option. We believe that option is out of the money next year. But when it goes back closer to the money or in the money, we'll exercise it.

The next question comes from Lance Wilkes with Bernstein.

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 kind of 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 performs 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.

With the question state-by-state, Mark and I spent a lot of time managing what we call the portfolio. and we do not tolerate performance SKUs, everybody's got to deliver. Now things go through cycles and sometimes the state rate will get weaker and then sometimes it gets stronger. But every property in the portfolio is performing at least in excess of its cost of capital. There's a supposition out there that some of the smaller plans can't be doing well because they can't be scaled properly. We have $5 billion health plans, and we have $500 million health plans. The margins are not correlated to the size of the plan. They're just not. We can make money in a $500 million to $1 billion health plan, all the shared services, claims, grievances and appeals all those shared services call centers are completely leveraged at an enterprise level. So right now, sure, states go through -- our state properties, go through various cycles of profitability, ebbing and flowing. But no, there is no contemplation of reducing the size of the portfolio. We still have an active pipeline targeting $54 billion of opportunities over the next number of years. We have 2 active RFPs, 2 of our bigger states in flight right now. So now we're building the portfolio. And right now, there is no discussion over any underperformance or any state where we're not happy to do business.

The next question comes from George Hill with Deutsche Bank.

I had a Medicare question. And I guess, Mark, when I think of your portfolio in Medicare, I think you talked about like the LTSS and the duals penetration, I think if you guys as having high duals in a relatively sick book of business, which is why I was surprised at the magnitude of the MLR miss in the quarter. I guess, can you talk about the variable consumption that you guys saw in the Medicare business? And what's driving that because, again, I think the really sick members is constant utilizers of care. So I kind of really like to hear about the marginal -- like what's driving 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 of the 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 2 cost components in Medicare, LTSS hours and SNF admits and high-cost drugs, which are our Rx trends as a company are about of 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.

The next question comes from Michael Ha with Baird.

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 fare 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.

Right.

Our last question comes from Jason Cassorla with Guggenheim.

Great. Maybe just piggybacking off of the benefits questions from Medicaid. You noted program construction isn't like a phenomenon for 2026. But as opposed to multiple years of elevated rates, discussion around being 300 to 400 basis points underfunded in Medicaid. What do you believe needs to happen for states to take a deeper look at benefit structures and find areas that they'd be willing to pare back? And what would be like the mechanism or timing around when that could possibly happen? Or do you see a greater honors for states to do that and look at benefit structures?

Well, they do from time to time, carving out pharmacy, putting pharmacy back in. And the real issue there is while we don't like to see swings in revenue, revenue, we like to see revenue coming in. We certainly don't like to see it leave. The real issue there is if they take out benefits, how much rate do they take out? Do they take out the right amount of rate for the reduced benefit. So it should be margin neutral that and over time, it usually is. But there are value-added benefits in many states. I mean there's the core essential benefits that you'd always provide, but there were benefits around the edges that are always provided where they could actually cut back. States tended to have a tendency to carve out pharmacy. Some states have done that and found that it increased costs substantially. So we don't see that as a new emerging phenomena, there's 4 or 5 states that already do it. We don't see any more that are inclined to do it. So I think around the edges, they will look at that in order to save money. It will reduce revenue, but as long as the right amount of rate is taken out of the capitated rate, then volume goes down a little -- premium volume goes down a little bit, but margins should be neutral and should not be affected.