Regina Nethery - Vice President of Investor Relations Bruce D. Broussard - Chief Executive Officer, President, Director and Chairman of Executive Committee Brian A. Kane - Chief Financial Officer and Senior Vice President James E. Murray - Chief Operating Officer and Executive Vice President Steven E.

McCulley - Chief Accounting Officer and Senior Vice President.

Joshua R. Raskin - Barclays Capital, Research Division Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division Albert J.

Rice - UBS Investment Bank, Research Division Justin Lake - JP Morgan Chase & Co, Research Division Matthew Borsch - Goldman Sachs Group Inc., Research Division Andrew Schenker - Morgan Stanley, Research Division Stephen Baxter Ralph Giacobbe - Crédit Suisse AG, Research Division Carl R.

McDonald - Citigroup Inc, Research Division Ana Gupte - Leerink Swann LLC, Research Division Scott J. Fidel - Deutsche Bank AG, Research Division David H. Windley - Jefferies LLC, Research Division Sarah James - Wedbush Securities Inc., Research Division Brian M.

Wright - Sterne Agee & Leach Inc., Research Division Christian Rigg - Susquehanna Financial Group, LLLP, Research Division Michael J. Baker - Raymond James & Associates, Inc., Research Division.

Good morning, and welcome to the Humana third quarter earnings conference call. [Operator Instructions] Thank you. Regina Nethery, you may begin your conference..

Thank you, and good morning. In a moment, Humana's senior management team will discuss our third quarter 2014 results, our updated earnings outlook for the remainder of this year and our detailed financial guidance for 2015.

Participating in today's prepared remarks will be Bruce Broussard, Humana's President and Chief Executive Officer; and Brian Kane, Senior Vice President and Chief Financial Officer. Following these prepared remarks, we will open up the lines for a question-and-answer session with industry analysts.

Joining Bruce and Brian to the Q&A session will be Jim Murray, Executive Vice President and Chief Operating Officer; Steve McCulley, Senior Vice President and Chief Accounting Officer; and Christopher Todoroff, Senior Vice President and General Counsel.

We encourage the investing public and media to listen to both management's prepared remarks and the related Q&A with analysts. This call is being recorded for replay purposes. That replay will be available on the Investor Relations page of Humana's website, humana.com, later today.

This call is also being simulcast via the Internet along with a virtual slide presentation. An Adobe version of today's slide deck has been posted to the Investor Relations section of Humana's website. Before we begin our discussion, I need to advise call participants of our cautionary statement.

Certain of the matters discussed in this conference call are forward-looking and involve a number of risks and uncertainties. Actual results could differ materially. Investors are advised to read the detailed risk factors discussed in this morning's earnings press release, as well as in our filings with the Securities and Exchange Commission.

Today's press release, our historical financial news releases and our filings with the SEC are all available on Humana's Investor Relations website. Call participants should also note that today's discussion and slide presentation include financial measures that are not in accordance with generally accepted accounting principles.

Management's explanation for the use of these non-GAAP measures is included in today's slide presentation, as well as a reconciliation of GAAP to non-GAAP financial measures. Finally, any references to earnings per share, or EPS, made during this morning's call refer to diluted earnings per common share.

With that, I'll turn the call over to Bruce Broussard..

number one, meaningful Medicare Advantage membership growth, especially in our HMO products; two, successful management of clinical program engagement even with higher membership growth; three, achieving clinical cost reductions that allowed us to stabilize member premiums and benefit changes in light of a 5% Medicare funding cut from CMS; four, achieving our financial -- targeted financial performance for our health care exchanges and state-based contract businesses, including adding approximately $6 billion of incremental annualized revenue associated with these 2 strategically important programs; five, continued improvement in our Star ratings; and six, maintaining our median EPS target on an adjusted basis, notwithstanding the various headwinds and investments for the future we made during 2014.

As we look to 2015, we anticipate EPS to grow approximately 17% from our 2014 adjusted EPS and are guiding to a range of $8.50 to $9.

We believe our earnings growth trajectory will resume next year as the enterprise-wide benefit of our higher membership levels, particularly in Medicare, and other benefits associated with consistent implementation of our strategy more than offset another round of headwinds in 2015.

These headwinds primarily include a higher insurance industry fee, reduced Medicare Advantage funding from CMS and higher trends from Specialty drug costs. We also expect our revenues to grow substantially and are predicting top line growth of more than 10% for 2015.

This revenue growth is primarily enabled by a higher membership in our Medicare businesses and a full year of revenues associated with our state-based contracts. As you can see from Slide 5, we are focused on the areas with the highest projected growth opportunities across the sector.

The competitive pricing environment for commercially fully insured business remains rational, but we are seeing some aggressive pricing moves in the larger-case self-funded business.

The latter has caused some significant membership losses in our ASO businesses that became effective next year, but we're not anticipating a significant impact upon our consolidated earnings.

I'll now provide you a bit more depth on our membership expectations for business expected to experience the greatest long-term growth, beginning with the Medicare Advantage. As we look to 2015, we are expecting Individual Medicare Advantage growth in the range of 235,000 to 255,000 members.

We believe members will be pleased with the continuing value proposition we are able to provide next year, as well as the stability of our benefits and premiums. Approximately 2/3 of our Medicare Advantage members will not see a premium increase in 2015, while the remaining 1/3 will see an increase of only $10 per month.

In an environment which saw funding reductions of approximately 2%, juxtaposed against medical cost trends in the low single digit, this speaks volumes to the benefits of our integrated care delivery model.

We also expect to see continued growth in our stand-alone PDP offerings and anticipate a growth of 475,000 to 525,000 members, with the primary driver of that being our low-priced co-branded Walmart plan. Turning to our expectations for HumanaOne membership.

We do expect to see some attrition, driven by increased competition in our 2015 pricing strategy, including the necessary premium increases associated with the transitional policy changes and the preparation for the elimination of 2 of the 3Rs in 2017. Nevertheless, we expect that to be a temporary pause in growth.

And importantly, we are forecasting breakeven results for this book of business in 2015. Our state-based contracts are expected to remain relatively flat next year, as we continue to implement the contracts that became effective in 2014.

However, we are anticipating becoming active in the state-based contract RFPs again sometime next year, leading to higher membership growth and ultimately long-term profitability. Our strategy is to make it easy for people to achieve their best health with clinical excellence through coordinated care. This puts the consumer at the center.

One benefit of the consumer at the center is quality of care. We see our recent Star rating results as a proof point that our strategy is taking hold. We are very pleased that approximately 92% of our current members will be in a 4-star or higher-rated plans in 2015.

In addition, our CarePlus plan in South Florida achieved the highest Star rating of 5 stars, allowing year-round sales for this plan, the only publicly traded 5-star plan in the country.

A significant driver of these high-star ratings is the cumulative benefit achieved through our clinical programs, predictive modeling and integrated clinical IT platform. We continued to increase our members' participation in our clinical programs.

For example, while Medicare Advantage membership year-to-date is up approximately 16%, enrollment in our Humana Chronic Care Program has grown more than 35%. Besides favorable impacting our members' clinical outcomes, our clinical programs are continuing to show solid return on investment.

The top 3 programs in terms of medical cost savings generate ROIs of at least 3:1. This gives us confidence that we continue to provide a better health experience for our members while achieving favorable results for our shareholders. Another leading indicator that we monitor relative to our strategy is the engagement of our associates.

Engaged associates are the best way to our -- our strategy is consistently implemented, enhancing the overall consumer experience. Our 2014 associate engagement survey conducted by an independent organization shows engagement in the 91 percentile, a world-class ranking.

So what does all of that mean for our shareholders? We believe the achievement of these strategy proof points leads to an annual revenue and earnings per share growth rates and return on invested capital justifying the confidence you have shown in Humana to date. I'd like to also provide a brief update on the evaluation of our PBM business.

We have concluded that we would not sell this asset since we failed to see a compelling strategic or financial justification for doing so. However, our evaluation of this important asset continues across a number of fronts, including retail network purchasing and pharmacy inventory procurement and fulfillment.

We continue to assess this and other opportunities, and we'll keep you apprised of our progress. This PBM analysis is part of the stronger focus on return on invested capital across all of our businesses. We continue to evaluate each of our businesses to ensure they are exceeding their cost of capital and are strategically significant.

So let me summarize the quarter by noting that our core Medicare business is performing well and is expected to continue to grow and prosper. Our individual commercial business is starting to stabilize, and we expect breakeven results for 2015, including lower reliance on the 3Rs.

Implementation of our state-based contracts is on track with our expectations. Our Healthcare Service segment is expected to continue to grow and expand in correlation to our growth in our Retail businesses, in particular, Medicare. And finally, 2015 is expected to be a year when strong growth in earnings resumes for Humana.

We look forward to sharing our strategy and outlook in more depth at our Investor Day on December 4 in New York City. With that, I'll turn the call over to Brian for a more detailed discussion of our financials..

chronic care management for Humana At Home, pharmacy management, in-home clinical assessments, network management and claims cost management. We expect modest changes to our members' benefits, commercial premium increases and operating cost efficiencies to address the remainder of the shortfall.

We have worked to mitigate the impact upon our members of premium increases and benefit changes in our Medicare Advantage business, while also balancing the potential impact of such changes on minimum medical loss ratios and competitive dynamics.

From an operating cost-efficiency standpoint, we continue to focus on streamlining costs and processes wherever possible and have incorporated assumptions around specific initiatives generated from our ongoing internal operational cost and productivity review.

All in, we expect operational improvements, net of a negative impact of Medicare rate cuts and secular medical cost trends, to benefit earnings by $1.40 to $1.50 per share in 2015. Turning to membership. We expect strong growth in 2015 resulting in an enterprise-wide benefit.

As we've shared with you in the past, the new Medicare Advantage members we add each year do not immediately result in higher earnings for the Retail segment.

However, as they renew in year 2 and each of the subsequent years, we experienced improvement in the benefit ratio for the cohort, as we've engaged these members in our care management programs and more accurately documented their conditions.

Therefore, renewing members associated with our 2014 Medicare Advantage membership growth, along with the normal progressive improvements of our remaining membership, are expected to favorably impact our Retail segment results.

We expect our Healthcare Services segment to see a more immediate benefit from the 2015 cohort of Medicare members due to the crossover benefit of service expansion in our Pharmacy Solutions and home-based services businesses.

As we've noted in the guidance points of our earnings press release this morning, our Employer Group segment faces some membership headwinds in 2015, focused primarily on the highly competitive ASO business where we are committed to remain disciplined in our pricing.

Our team is proactively taking the related operating costs out of the system, and thus, we do not expect significant earnings pressure from the loss of this membership next year. All in, the net growth in medical membership is expected to be additive to earnings in 2015 by approximately $0.75 to $0.85 per share.

Another driver of higher earnings for 2015 is pricing our Medicare bids and commercial products to address higher costs associated with Hepatitis C. We believe these pricing adjustments in our Medicare bids are sufficient. And for commercial, we believe that we have captured most of these costs in our renewal pricing.

This will largely eliminate the related headwind we are seeing in 2014 of $0.40 to $0.50 per share, thus leading to the year-over-year improvement.

Our investments in health care exchanges and state-based contracts will also be reduced by approximately $0.30 to $0.40 next year to $0.30 to $0.35 of investment spending for 2015, as we anticipate generally breakeven results for health care exchanges and improving results in our state-based contracts.

As we've shared with you previously, we anticipate the state-based contracts will take 2 to 3 years to normalize. Our projection for health care exchange results includes a significant reduction in our reliance on the 3Rs, with an expectation of receivables in the range of $325 million to $400 million in 2015 or about 1/2 of the 2014 level.

The large majority of these receivables continue to come from reinsurance. The state-based contracts results are also expected to benefit from a full year of revenues on the contracts versus approximately 6 months on average for 2014, as well as progression towards a normalized benefit ratio.

We have also included the impact from share repurchases in our 2015 forecast. As noted in the press release we issued in September, we have increased our share repurchase authorization and intend to execute approximately $1 billion in stock buybacks by June 2015. In October, subsequent to that announcement, we completed $100 million of buybacks.

And later today, we expect to sign an agreement to initiate a $500 million accelerated stock repurchase program. Thus, we anticipate approximately $0.25 in incremental benefits, net of interest expense, for 2015 resulting from our capital deployment strategy.

As we evaluate each of the components of our earnings waterfall that I just described, we are confident in our earnings per share guidance of $8.50 to $9 for 2015. Turning to Slide 12.

Before expanding on our capital structure, I would like to first provide some color around our Medicare margin, as we recognize that this is an area of focus for our investors, as well as discuss a broader enterprise view for 2015 and beyond. At the time we submitted our 2015 bids, we were anticipating pretax margins approximating 5%.

Our current 2015 forecast calls for margins that are more in the 4.5% to 5% range due to some factors that have changed since the submission of our bids in June. First, we saw higher membership than we had assumed in our 2015 bids, driven by greater-than-planned growth in the latter half of 2014 and our current estimate of 2015 membership growth.

One of the realities associated with our high Medicare growth is that, as I mentioned previously, it takes time for our chronic care management programs and other trend vendors to reach their potential value for these members. This has the effect of depressing the overall margin due to the higher revenues from this membership.

Additionally, our current 2015 outlook contemplates a slightly higher level of overhead absorption in our Medicare business as a result of the relative change in scale of all of our business units.

It is important to note, however, that this higher growth level also results in more opportunity for our Healthcare Services businesses, such as our PBM, Humana At Home and behavioral health units, which, in total, results in greater overall enterprise value.

We believe looking at growth from an overall enterprise view is the best way to think about our returns.

To build on that point, we expect our Healthcare Services segment results to reach approximately $800 million in 2015, up over 50% from 2013 levels, which are dollars that would otherwise be paid out to third parties to provide these critical services that benefit our members had we not invested in our integrated care delivery model.

More importantly, we believe the value to our members derived from integrating all these capabilities internally far exceeds what could be achieved by vending these capabilities to third parties. We therefore are very pleased to be continuing our growth trajectory while simultaneously reaching our overall enterprise targets. Turning to Slide 13.

The final topic of my remarks this morning will be to review the company's capital structure and the related impact upon capital deployment. First, near the end of the quarter, we issued $1.75 billion of senior notes and announced the early redemption of $500 million of our 2016 notes.

Together, these actions lowered the average cost of our debt by approximately 85 basis points, while lengthening the average maturity profile by more than 4 years. We also established a $1 billion commercial paper program that provides us with additional financial flexibility. These actions highlight our commitment to optimizing our capital structure.

We believe that our current debt-to-capitalization ratio strikes an appropriate balance around the objectives of maintaining ample capacity to invest for long-term growth in our existing businesses, regularly returning capital to our shareholders and providing financial flexibility should strategic M&A opportunities arise.

To conclude, we expect the resumption of earnings growth in 2015 with approximately 80% of that stemming from operational improvements and membership growth and the balance coming from capital structure optimization. We continue to believe that the execution of our strategy holds promise for growth in the years ahead as well.

With that, we will open the lines up for your questions. [Operator Instructions] Operator, please introduce the first caller..

Your first question is from the line of Josh Raskin..

I just want to talk about the overall Medicare business in light of the commentary you made around the margins. I just want to clarify, Brian, that the 5% margin is still your long-term target, that's part of your bid process, that's what you did last year, that's what you'll do next year, et cetera.

It's just a little bit of headwind in -- yes, I guess there's a little bit of headwind coming in since the bids have been made.

And I guess, if I'm going to cheat a little bit, the second part is, within your targeted growth for Medicare Advantage of 8% next year, that implies a relatively similar environment, all else being equal, to what you guys were thinking about coming into the year this year.

So I know the fee is up, the reimbursement continues to get more burdensome, I guess, and cumulative impact.

But is it fair to say you guys think, yes, the MA environment is the same as what we've seen in the last year or 2?.

Well, Josh, I'd say in your first question, I would say that our margin targets really are in the 4.5% to 5% going forward. We're going to take it on a year-by-year basis. It's important to think about this, as both Bruce and I have emphasized, as really an enterprise view and we think holistically about our business.

And so we'll look at it year-by-year and figure out what is the right margin target to target. But I would say that our long-term targets are really more in the 4.5% to 5% range, and we'll take it on a year-by-year basis, depending on a whole host of factors, including the competitive environment, the rate environment, et cetera.

I would say, to your second question, that we feel pretty good about where the Medicare environment is. I think we feel that our competitive positioning is very good. Our integrated care delivery strategy is working.

And so we continue to expect to grow the Medicare business, which again, has the ancillary benefits on the rest of our enterprise, which again, we can't emphasize enough how important that is..

So Brian, just a follow-up, and I don't want to get caught up in semantics around 4.5% to 5% versus 5% historically. There's not a material difference.

But what's changed? Why not 5%? Is there some feedback you've gotten from CMS? Is there competitive positioning where you think others are targeting lower margins? Or what exactly has changed that outlook for you guys?.

Well, I don't think there's any specific. I think our view is that just having a specific margin target at a point estimate is not prudent as we think about maximizing the overall enterprise view. We think, as you said, the 50 basis point difference doesn't have a significantly material impact on our business.

And so as we think about holistically what the way to drive the overall results are, we're going to maintain flexibility depending on the overall market conditions. But I think broadly our view, as we've said on the Medicare business hasn't changed. We're very positive on where we think it can go and the growth we think we can achieve.

And if you look back at our results, I think it's very clear that, that's occurred. If you go back and look at our Healthcare Services results and look at where we were profit-wise in 2013 and where we're projecting for 2015, I think that gives you a sense of the power of our integrated care delivery model.

And so I think that's really what's driving our perspective there..

Your next question is from the line of Peter Costa..

Sort of along that same line. I'm looking at your guidance for Medicare Advantage growth in the Retail segment, you're projecting a slowdown in growth, and yet, you've got fewer headwinds. You should have a better performance relative to the Star program and your MLRs are the same.

So why are you projecting a lower growth that's actually not better than the market? It's just what the market has been growing recently..

Well, Peter, we'll see how the competitive environment unfolds and how we do. We feel very good about where we are. We'll see if we can exceed those targets. But that's where we think a reasonable place to be is at this point..

Yes, this is Jim. We're 2 weeks into the selling season and things seem to be going very nicely. But this was our attempt at putting a number out there that made some sense, and we'll see how it ultimately plays out..

Was there something that happened this past year that caused your membership to grow so much faster than the market and you're just looking at sort of market growth going forward? Or is there something else that I should be thinking about in terms of just conservatism in your number?.

In 2014, as Brian talked a moment ago, our trend benders were very, very positive, as they will be for 2015. We -- relative to the competition, we had a very good value proposition in a lot of the markets that we do business, and we see that same kind of value proposition playing itself out in 2015. So it's very early.

Let's see how the remainder of the year plays itself out..

To be more specific, on 2014, there were some competitor reactions that inured to our benefit that, I think, helped us grow in '14. We don't see that in '15 as much. And so we brought our estimate back down to what is a normal growth rate for the organization..

Your next question is from the line of A.J. Rice..

I guess I'll just try to flush out a couple of points on your guidance, if possible. I know last year, when you did the guidance, you had sort of backed out prior period development going forward, and I didn't see that as a line item.

Is that incorporated somewhere in the forward guidance? And then just maybe a little bit more on Hep C and the buyback. What -- does the buyback have more in there beyond the accelerated repurchase today? Or is that sort of all that you've incorporated in there? And then in Hep C, I guess, you're sort of unique in highlighting that as an opportunity.

And maybe flush out a little bit more of how you're going to -- is that just a matter of getting it priced right next year versus this year?.

A.J., this is Steve. I'll take part 1 of that question, which was last year, when we rolled forward from '13 to '14, we had a higher level of PPD in '13 that we didn't see playing itself out at a similar level into '14, so we normalized that as we rolled forward from '13 to '14.

We think now we're more at a more normal level, so we don't have the same adjustment as we roll forward from '14 to '15..

Yes. And on your second question, A.J., with regard to Hep C. Look, we thought it was important to highlight that we're -- feel that what we've put in our Medicare bids are sufficient to cover that headwind, as well as in our commercial pricing.

And so we want to call that out because that's a number that we had as we rolled forward from -- during the year in 2014. So it was important to call that out, that we reflected that. And in terms of share repurchase, that is correct, there is additional repurchase assumed in the back half of the year..

Your next question is from the line of Justin Lake..

I've got a few follow-ups here on the numbers. First, on the margin target. Understand your comment on moving away from a point-specific target to this new range. Just wanted to get some commentary on your thoughts looking ahead.

Can you confirm that you think this is a sustainable range, given everything you know on the business today versus what you used to say this 5% is sustainable? And then on the 8% membership growth for '15, I'm surprised that that's ahead of your original expectations, given what we've seen from the market over the last 5, 6, 7 years.

So can you tell us what you expected previously and what you think sustainable Medicare Advantage enrollment is going forward?.

Sure. So on the -- look, we think that the 4.5% to 5% is a number that's, like we said, reasonable going forward. And I think that's where we want to continue to strive to hit.

As we've said, nothing -- really, going back to my -- an earlier comment, I think that's just what's prudent to do as we think about maximizing the overall enterprise value here. With regard to the membership growth, I would say we're, call it, probably 40,000 members ahead approximately of where we were in terms of the 2015 guidance expectation.

When we were setting the bids back in June, we're probably about 40,000 members ahead of that. Again, we'll see where this ultimately plays out. We think those are reasonable growth targets, and we feel pretty good about where those are..

Your next question is from the line of Matthew Borsch..

I just wanted to come back to your bid for 2015. And I appreciate what you said about the member mix given your higher growth, and that's a headwind.

But don't you also have a tailwind from the fact that Medicare utilization generally has maybe, correct me if I'm wrong, been favorable to what you reflected in your bid back in late May?.

I would say that the Medicare utilization, in terms of our expectations, I mean, what we've seen play out through the balance of 2014 have really been in line. As you know, Matthew, we really look at admits per thousand from an inpatient trends perspective. We track that really rigorously, and it's really in line with where we expected.

In the early part of the year, you're right, it outperformed a little bit in terms of those numbers were slightly better than forecast, but our expectation was that it was going to come back to within where our expectations were. And as we roll that forward to 2015, we expect it to really remain in line..

So when we did the bids, we do reflect what we think the trend benders will be in that appropriate year. And so in 2015, we've included the trend benders in there. And in 2014, the latter part, the trend benders continue to be an expectation of both as opposed to overachieving or underachieving..

Okay.

And looking ahead, do you see the Medicare utilization with the caveat of the member mix remaining about where it's been?.

This is Jim. The utilization on Medicare has gone very well this year, with Humana At Home playing a large role. There was some favorable utilization in the first couple of months because of the cold weather.

The other thing that I would just quickly remind you of related to 2014 is that when we thought our group business was doing better at the beginning of the year, we made the decision to invest an additional $100-and-some million for 2015's trend benders, which is putting a little bit of a drag on our Medicare results for 2014.

So that's part of the offset that I would highlight for 2014. But utilization is really strong. We're really focused on Humana At Home and what kind of results that that's going to achieve for us and feel very good about that as we get our trend benders for '15..

Your next question is from the line of Andy Schenker..

So maybe switching over to exchanges for next year. I appreciate your expectation of kind of breakeven. But maybe if you could just highlight some of the changes you made in your offering and expectations, considering you're going to be offsetting over $300 million and its 3R dependency there.

And then also -- and any losses above that? And also maybe talk about your expectations around membership losses there or any of them from any specific medal tier or any specific geographies where you had more significant repricing..

This is Jim again. We feel really good about how we were able to grow this past year with the exchange business. As you all know, we doubled our membership from 0.5 million to about 1 million members, and we tripled our overall revenues up to $3 billion, which got us into a nice scale position.

We were able to do that because of the way that we designed our products and our networks and really focused on efficient networks in many of the markets that we offered the product. That enabled us to probably be in a 1 to 2 position in terms of low price.

And as we look at the competitive environment now that's deteriorated a tad, although not significantly, so it's such that we're probably somewhere between second to fourth lowest in a lot of the markets that we do business. But again, the price differential between the low plan and us right now is not that significant.

And so we're obviously going to test some of the persistency theories that we've got relative to this business. The drop is anticipated because we're going to lose some of our legacy business, not exchange business.

But just trying to be cautious in terms of what we're guiding for next year, given the new competitive marketplace and some of the issues that will likely occur because of the subsidy changes that are going to take place with the new competitors in the marketplace..

Your next question is from the line of Kevin Fischbeck..

This is actually Steve Baxter on for Kevin. So I wanted to kind of follow up actually on the individual enrollment projection. I guess, with the exchanges forecast to grow substantially, this seemed a little bit surprising, even given the pricing changes.

I guess, could you kind of break it down a little further into what you expect in terms of retention on your exchange book, your non-exchange book, and what you think it will capture next year?.

Look, I think, as Jim said, on the legacy side, we do expect attrition there, and we'll see where they ultimately go. It is a price-sensitive market, and so as we forecast for 2015, I think we're mindful of the fact that this market hasn't been in existence very long. And so while brand and loyalty will play some role, it's still early days.

And so we're trying to really just understand where we are positioned competitively, and we'll see how this ultimately shakes out. But I think, given where we are from a price position perspective, as Jim articulated, that's really why we're forecasting the way we are forecasting. We do expect the on-exchange members to remain around the same.

And you're right, we are assuming that the market will grow. In our pricing, there is an assumption that the market will grow, that the -- effectively, the morbidity of the market will get better. And that's part of our pricing assumptions, as well as the reduction in really almost in half of the 3Rs.

But it's still early days, and we'll see how this plays out..

Okay.

As a follow-up, what is your current exchange enrollment?.

It's about 1 million..

No, that's all-in..

Oh, I'm sorry. It's 700,000 on the exchange and 300,000 legacy..

Your next question is from the line of Ralph Giacobbe..

I was hoping you can give us a sense of where your individual book margins are running for this year and sort of what that implies for the, I guess, Medicare book margin this year as well?.

When you say individual, do you mean H1? But we're just....

Yes, just the -- yes, your -- just individual book, both on and off exchange..

Yes, I mean, look, I think it's clear, we're -- all-in, we're losing money this year. It's like we have these investments in the exchanges. I mean, we'll broadly lose in the $60 million range all-in this year on the individual side, and we expect to take that to breakeven this coming year. So that's broadly how we think about it.

And as I we -- as I articulated in my remarks at the beginning, we still expect some investment, but that's on the state-based side. We're hopeful that will break even this year on the exchange side..

Okay. And then your Medicare book, I guess, excluding those with the drag, I'm just wondering what the baseline is in terms of your margin performance so far this year..

Yes, we don't disclose that level of detail in our Medicare book. I mean, you have what our retail margins are. And that's -- and I'd just point you back to my remarks at the beginning as to what our margin targets are for the Medicare business..

Your next question is from the line of Carl McDonald..

This historical 5% Medicare margin was based on a 35% tax rate. The go-forward 4.5% to 5% is now a 50% tax rate.

So is it right to think about, on an after-tax basis, you're saying the go-forward Medicare margin is going to be, call it, 25% lower, ignoring for a second the positive impact of Healthcare Services segment?.

Look, I guess it's fair to say that. I mean, there's no doubt that the margin that we've articulated is a pretax number, and we are faced with a much higher effective tax rate next year approaching 50%. So it is fair to say that the overall margins, as everyone is facing because of the industry fee, have been reduced..

Your next question is from the line of Ana Gupte..

So again, following up on the 4.5% to 5% target margin, if we fast-forward to 2016, would you be able to articulate what the drivers are of your Star performance? And with such a conservative target margin and 90% of your plans in 4-star, what you might do to deploy that pretty massive listing [ph]?.

This is Jim. There's probably 10 things that go into our favorable Star positioning. Bruce talked about some of them earlier when he talked about predictive modeling.

We have teams of people who are identifying each of the individual geographies and age contracts in each of the cells of the various Star measures to identify where we predict that will be relative to each and every one of those. We've got a team of people in the markets.

We've literally created folks who are called Star Czars in the markets who are focused on driving Star results for us as an organization. We have a layer of people here at corporate who do an amazing job, hundreds of people who are focused on how we're doing market-by-market, organizing our efforts.

We're also doing a lot of things -- you've heard about our CareHub workflow and messaging capabilities. We're literally sending messages to our members and their doctors about where they stand relative to care gaps, which we'd like to get close so that our HEDIS scores improve.

We're also doing things around our customer service organization and the related impact that, that has on Stars measures. And so it's a really incredible effort that comes together nicely every year.

And I think that you'll see continued improvement from us going forward, which, as you correctly pointed out, really helps us with our overall revenue perspective into the future..

So would you say then, given that the secular growth rate is mid- to high-single digits 2016 and beyond, you probably have flat to positive rates, but you're the leader here, so you could grow at mid-teens at the very least?.

We do a good job with Stars, and we do a good job with trend benders. And as you know, the offset of that is funding from the government.

And I think in over the last couple of years, we've demonstrated that we are able to manage through that headwind fairly well and grow, which is, frankly, a big part of the story here is our ability to grow organically. And our Medicare business, I think, is really -- differentiates us from a lot of folks..

So I'd tell you, maybe to bring more specifics to the growth rate. We do -- Medicare is growing at about 3% per year. The number is fairly large. And from a number point of view, but we do see Medicare Advantage growing greater than the Medicare number as a result of the growth in the participation within the Medicare Advantage program as a whole.

We also believe, as Jim has articulated, that our clinical programs, including our Stars ratings, gives us a competitive advantage in the marketplace, allowing us to keep our rates stable and then continuing to ensure our value proposition is one of the higher-competing competitors in the marketplace.

So we do believe that we will take more of that share as we've demonstrated in the past. And so when we think about a sustainable growth going forward, we think the clinical program really is the engine that allows that growth, and then you combine that with the demographic aspect to it, it seems to be a very intriguing market for us long term..

Your next question is from the line of Scott Fidel..

Just interested on the assumption for the Hep C recovery around $110 million. What are you building in, in terms of Harvoni into that? It does look like the script volumes are starting out pretty robust here initially.

And then just relative to Hep C, just help me just understand, with the Employer Group guidance, where that $30 million of Hep C benefit actually flows through on the metrics? Because it looks like you're guiding for stable MLR year-over-year in the Employer Group, and then you've got the pricing for the industry fee that theoretically be impacting that as well.

So just interested in terms of where that $30 million benefit actually shows up on the Employer Group..

Sure. On -- it's Brian. On Harvoni, we are anticipating an increase in utilization of that drug, and we've modeled that and forecast that, and that's anticipated in our pricing. And so again, we feel pretty good about that, where that's priced for our Medicare book and our PDP book.

With regard to the $30 million, it will show up in the MLR line, the MER line, and there's a whole list of things, obviously, that drive that MER line, but that $30 million would show up there for sure..

Your next question is from the line of Dave Windley..

I was curious if the -- on the expenses-related state-based contracts that remained in the guidance for 2015, I think about $0.30 to $0.35.

Is that infrastructure ahead of revenue still? Or should we think of that as a steady level of investment that you will need to continue to make over multiple years to build up that program?.

I would say it's a combination of things. I think, generally, we've really ramped up the infrastructure. We're still doing that. Part of that also is getting to a stabilized MER ratio. We expect that to come down over time as we engage with these members, and there is clearly additional investment there. So it's really a combination of things.

But I'd say the MER getting to a stabilized ratio is pretty important, as well as continuing to scale up the business..

Dave, part of the issue related to next year was the lateness in some of those contracts in their start dates. The states weren't quite ready to give us a lot of those members.

And as a result of that, some of the investments that we would have otherwise made last year and got infrastructure in place, fixed infrastructure, is now having to be put together next year. So it's probably a little bit higher investment in '15 than we would have otherwise thought we were going to make last year at this time..

Okay.

And is that and perhaps the H1 business, are those the 2 factors that have your pretax retail margins at like 3.8% as opposed to the 4.5% to 5%? Are those the 2 things that I should think of as dragging that down? Did I categorize correctly?.

Yes, no, I think that's fair..

Your next question is from the line of Sarah James..

Your peers have all given us long-term top line or earnings growth outlook.

How should we think about those for Humana?.

Well, look, it's something that we're thinking a lot about. We'll potentially talk more about that going forward. I think suffice to say, today, as Bruce articulated, we feel very good about how we're positioned in the long-term growth perspective on this business.

From a top line perspective, given the -- from where our core business where, the significant number of agents we're seeing every day, the penetration of Medicare Advantage and our positioning within Medicare Advantage gives us confidence that we can continue to grow that book.

When you think about operating leverage, as we continue to ramp up the H1 business and start turning a profit there and the state-based business starts breaking even and ultimately turning a profit, we think we can drive material operating leverage, as well as we continue to scale up more broadly, and then we are going to have capital return as part of our regular commitment to shareholders.

And so when you combine that, we feel pretty good about what our top and bottom line prospects are..

Yes, maybe to clarify a little bit more. You had -- on Slide 5, there was the tier historical revenue CAGR of 14% and McKinsey study suggesting 7% to 8% MA growth through '19. And then earlier on the call, you talked about some market share gains being possible based on the strength of your offering and Star rating.

So if I kind of add those to the McKinsey projection, can we get to a sustainable top line growth in line with what you show as to your historical CAGR?.

Look, we're not going to comment on that at this point and give specific revenue growth targets. We would say that we're very pleased with our historical performance here. We're hoping we can achieve it. But this is a very complex business.

And we're not in a position, at this point, to give long-term guidance other than we feel very good about how we're positioned..

Your next question is from the line of Brian Wright..

Were those Reuters reports a couple of weeks ago accurate that you've hired Goldman to sell Concentra?.

We don't comment on specifics like that. I think the -- what shareholders should take away from is that we are constantly looking at our portfolio, both in businesses that are not strategically aligned and, in addition, businesses that are not returning the returns that we are looking for. And this is going to be a constant evaluation.

We're not going to speak about a specific company, especially when we haven't put out any kind of public discussion on it..

Is Concentra in the guidance then?.

Concentra is in the guidance..

Okay.

And then lastly, Brian, have you completed your capital review, given all the buybacks and the debt raising? Or is there more to go?.

Well, look, as I said earlier, we feel good about where we are from a debt-to-cap perspective. We think it gives us the flexibility of where we need to be. We'll always refine our perspective on where our balance sheet is and what our capacity is. But I would say, from a leverage perspective, we feel pretty good about where we are..

And so you've done a review of the M&A landscape?.

Well, we're always reviewing the M&A landscape. We're always looking at our opportunities, both organic to fund that growth, as well as inorganic. So that review is ongoing and will always be ongoing..

Your next question is from the line of Chris Rigg..

Just wanted to follow up on the earlier question on the prior year development. I just want to make sure that that's -- you guys are not projecting that to reoccur in 2015..

This is Steve. We have used the same reserving practices all the time from year-to-year, so we have a normal run rate. So there's not anything unusual, when we roll forward '14 to '15, we would expect the same level in both years, I guess, on a percentage basis, all things being equal.

Does that make sense?.

Sort of. I don't want to get bogged down on the call. But I guess others, as a course of business in your industry, typically wouldn't assume that to reoccur. I guess, is it somehow reflected in the MLR that this year is artificially depressed and you're going to see improvement year-to-year? Or....

No, this is all normal. So we just think about normal reserving practice results in a typical level of margin or redundancy at the end of the year. And then if you use the same practices, you're going to have the same level the following year.

And the only time that it really pops out as a reconciling item from 1 year to the other is there something changes or you had more than -- a lot more than you expected or a lot less than you expected. So the way we -- that's the way we think about it. So there's not a reconciling item for us going from 1 year to the next for this item.

And I'm not sure how others do it, but I would think that would be typical..

Your next question is from the line of Michael Baker..

You pointed to, obviously, the commercial ASO membership pressure and the pickup in select competitive dynamics driving takeaways.

I was wondering if there was any role of the private exchange in those results, and if so, could you give us some flavor of that?.

None of the cases that we lost for 2015 had an aspect related to private exchanges. It was a large case primarily that we lost because of some competitive reasons on the fees and some of the commitments that were made relative to medical cost, but we just didn't think we could go to.

As with respect to private exchanges, we're doing a lot of work to understand them, not only from a larger group perspective, but also small group perspective.

We're doing a lot of the same things that our competitors are with testing some of the exchanges that are being brought up by the consultants and the broker community, and we also have our own proprietary exchange.

So we're not seeing a significant amount of movement yet with respect to the exchanges, but we're starting to -- trying to understand where we think that will go..

I think where we are in the private exchange maturity is, as people are trying to understand that we're preparing for some conversions over the longer period of time, but in today, we're seeing those conversions..

At this time, there are no further questions..

Well, like always, we thank each of you for your support for the organization and also especially our 55,000 associates that should take credit for improving the health of our members and also creating long-term sustainability returns for our shareholders. I wish everyone a great day, and we thank you..

Thank you. This does conclude today's conference call. You may now disconnect..