Amy K. Smith - Humana, Inc. Bruce D. Broussard - Humana, Inc. Brian A. Kane - Humana, Inc..

Peter Heinz Costa - Wells Fargo Securities LLC Kevin Mark Fischbeck - Bank of America Merrill Lynch Justin Lake - Wolfe Research LLC Matt Borsch - BMO Capital Markets (United States) Joshua Raskin - Nephron Research Ana A. Gupte - Leerink Partners LLC A. J. Rice - Credit Suisse Securities (USA) LLC Chris Rigg - Deutsche Bank Securities, Inc. Gary P.

Taylor - JPMorgan Securities LLC David Styblo - Jefferies LLC Zachary W. Sopcak - Morgan Stanley & Co. LLC Sarah E. James - Piper Jaffray & Co. Christine Arnold - Cowen & Co. LLC.

Good morning. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Humana Third Quarter 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Ms.

Amy Smith, you may begin your conference..

Thank you and good morning. In a moment, Bruce Broussard, Humana's President and Chief Executive Officer and, Brian Kane, Senior Vice President and Chief Financial Officer, will discuss our third quarter 2017 results and our financial outlook.

Following these prepared remarks, we will open up the lines for a question-and-answer session with industry analysts. Christopher Todoroff, Senior Vice President and General Counsel, will be joining Bruce and Brian for the Q&A session.

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.

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 our third quarter 2017 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 also available on our Investor Relations site.

Call participants should note that today's discussion includes financial measures that are not in accordance with Generally Accepted Accounting Principles, or GAAP. Management's explanation for the use of these non-GAAP measures and reconciliations of GAAP to non-GAAP financial measures are included in today's press release.

Finally, any references to earnings per share, or EPS, made during this conference call refer to diluted earnings per common share. With that, I'll turn the call over to Bruce Broussard..

care coordination, remote monitoring, telemedicine, and the provision of care in the home through nurses and doctors.

The insights we've gained from owning home health agencies demonstrates the value of having a home health platform to evolve capabilities and services, including integration of data, advancing moments of influence and transforming home health to Value-Based reimbursement.

This model produces improved outcomes, such as lower admissions, re-admissions and emergency room visits and common high-cost conditions, including congestive heart failure, diabetes and COPD. This is a change from today's Fee-for-Service home health reimbursement model, which does not encourage the holistic management of health.

It also provides us with an additional touch point with our members to enhance engagement, trust and close additional care gaps, such as missing HEDIS measures. Many aspects of the care coordination are already in place and we continue to look for ways to expand and optimize these capabilities.

For example, our entry into the Long-Term Support Service business via our acquisition of American Eldercare in 2013, and the beginning of what is today our Humana At Home business with the acquisition of SeniorBridge in 2012, are becoming even more important as we continue to seek greater linkage of the Medicare D-SNP population and Medicaid Long Term Support Services.

However, other aspects of this strategy, particularly the provision of care in the home, will require M&A and other partnerships for collaborations to effectively bring them to life, as we've discussed previously. In order to advance our strategy, we need to continue to evolve the capabilities of our Healthcare Service segment.

Accordingly, over the last several months, we have been working on a newly refined operating model to better align the Healthcare Services segment strategy, business and processes.

The new organization will afford us a greater opportunity to engage our members, patients, physicians and associates to drive the best possible financial and clinical outcomes.

With this new organization, we recently named new leaders of both our Home and Pharmacy operations, who will work under the leadership of William Fleming, President of Healthcare Services. We welcome Kirk Allen to Humana to lead our Home operations as President of Home Care.

Kirk brings more than 20 years of experience in health care and was most recently the President of Ascension At Home and Executive Vice President of Home Care Services at Evolution Health. We also welcome Labeed Diab to lead our Pharmacy operations as President of Humana Pharmacy Solutions.

Labeed is a registered pharmacist who brings extensive operations, management and business development experience in both the retail and health care industries, most recently serving as Chief Operating Officer and Executive Vice President at Brookdale Senior Living.

Prior to joining Brookdale in 2015, Labeed served in executive leadership roles for Walmart stores since 2009, most recently serving as President of Health and Wellness, which included managing retail pharmacies. Now to touch on 2018.

We are confident in our Medicare Advantage competitive positioning, despite the return of the Health Insurance Industry Fee in 2018.

As a result of our over performance in 2017 and various cost-saving measures, we've made targeted investments in our product design, clinical programs and operating processes, which enable us to maintain stable benefits, simplify the member experience and improve clinical outcomes.

We've been proactive in our broker outreach this year, demonstrating for them our confidence in our stand-alone strategy and commitment to helping seniors achieve their best health.

Additionally, we've worked to simplify the broker experience by investing in technologies that enable them to have 24/7 access to our information, with further plans to roll out simplified enrollment tools in 2018. As a result, we expect to return to meaningful Individual Medicare Advantage membership growth in 2018.

Brian will provide additional commentary on our 2018 in his remarks. With that, I'll turn the call over to Brian..

Thank you, Bruce, and good morning, everyone. As Bruce mentioned, today we reported adjusted EPS of $3.39 for the third quarter, which is ahead of our previous expectations.

We raised our full-year 2017 adjusted EPS guidance to approximately $11.60 from our previous adjusted EPS guidance of approximately $11.50, and we increased our operating cash flow guidance by approximately $250 million at the midpoint to a range of $3.3 billion to $3.6 billion, primarily due to continued better-than-expected financial performance.

Our Retail results are in line with our most recent forecast and continue to significantly exceed our initial expectations for 2017, led by our Medicare Advantage business.

Consistent with the first half of the year, third quarter MA medical utilization trends, including hospital admissions and pharmacy spend, are running favorably relative to our pricing assumptions.

In addition to our Retail segment producing strong results, our Group and Specialty segment significantly outperformed our previous expectations, primarily due to favorable prior period development and better-than-anticipated utilization trends. Trend is now running at the low end of our initial expectations of 6% plus or minus 50 basis points.

Accordingly, we raised our pre-tax target for this segment for the second consecutive quarter from a range of $320 million to $340 million to a range of $350 million to $400 million. We also decreased our benefit ratio expectation to a range of 79.0% to 79.25% compared to our previous range of 79.75% to 80.25%.

The Group and Specialty segment continues to consistently deliver solid results due to the team's strong focus on productivity and on offering innovative products that resonate in the marketplace. We are pleased with the return on investment we generate from this segment.

As we discussed last quarter, while the Healthcare Services segment continues to generate profits and steady cash flow to the parent and, importantly, reflects the integration of our business model by delivering clinical excellence and trend benders for our insurance lines, we continue to see lower-than-expected mail order utilization, particularly for new members in our Humana Walmart stand-alone PDP offering.

Today, we slightly lowered our pre-tax target range for this segment to $900 million to $950 million from our previous target of $925 million to $975 million.

Turning to our Individual Commercial segment results, which are excluded from our adjusted EPS, we now expect Individual Commercial segment pre-tax income of approximately $150 million, up from our previous estimate of approximately $85 million.

Consistent with last quarter, these results reflect significant positive prior period development as well as lower-than-expected utilization in our ACA-compliant business. With regard to cost share reduction payments, we do not expect the impact of the recent Executive Order to be material for us.

As these collective results demonstrate, we've had a great year so far, with significant outperformance that has enabled us to take the opportunity to invest in our future, including higher AEP marketing spend.

This outperformance also results in higher compensation, as our performance-based compensation arrangements reward our associates for their excellent work. In addition, as Bruce discussed, we have taken significant actions to reduce administrative costs in a sustainable way for 2018 and beyond.

Some of these measures have resulted in incremental spend in 2017, including investments in analytics and enabling technologies that have significantly advanced our Integrated Care Delivery model, such as investments in our Big Data and our customer relationship management, or CRM, system, among others.

Our Big Data environment now enables us to integrate and routinely mine status sources such as clinician notes, home health assessments and social determinants of health data. Through our CRM, we now have comprehensive longitudinal data view of our members, which helps us know our members deeply and engage them effectively.

We have also made investments in the provider space to advance care coordination capabilities, focusing on interoperability and analytics to improve the provider experience.

And lastly, we invested in a number of productivity and expense management initiatives related to internal management systems as well as vendor contracting and rationalizing our real estate footprint across the country.

More fundamentally, we have completed the build-out of the Process Transformation Office, or PTO, and we recently named Process Champions and Owners for three critical processes that together comprise over $1 billion in administrative spend.

These include processing claims, resolving inquiries and issues and designing and delivering member communications.

The PTO is working diligently with leaders throughout the organization to optimize these processes horizontally across silos, and has already identified meaningful savings by connecting upstream and downstream workflows and eliminating inefficiencies while ultimately increasing automation.

We believe that by focusing on these core areas and then extending the PTO to additional processes over time throughout the organization, we can continue to reduce administrative costs and increase the reliability of our processes while improving the member and provider experience that together will set us up for sustainable growth over the long term.

Lastly, as a result of our efforts to continue to evolve and streamline the organization to align with our Integrated Care Delivery Strategy that Bruce has articulated, we've had to make some difficult decisions, including closing certain open roles and initiating both a voluntary Early Retirement Program and an involuntary Workforce Reduction Program that are expected to impact approximately 2,700 employees, or just under 6% of our workforce.

In the third quarter of 2017, we recorded charges of $0.54 per diluted common share associated with these programs, which has been excluded from our adjusted EPS. This has resulted in a higher operating cost ratio than initially expected for 2017, and we now expect to end the year at or slightly above the higher end of our previous forecast range.

We believe the culmination of these investments and our associates' hard work during 2017 has positioned us for a solid 2018 in the face of significant headwinds, in particular, the return of the Health Insurance Fee, or HIF.

While we do not intend to provide specific 2018 guidance until our fourth quarter call, I will now offer some higher-level commentary and direction about next year. I'll begin with membership.

We are only one month into the Annual Election Period for our Individual Medicare Advantage, but we are encouraged, albeit very cautious, with early sales results and our competitive positioning.

Our philosophy heading into this enrollment season was to maintain stable benefits for our members and, in some markets, improve benefits where we believe we were well-positioned relative to the competition.

We did this recognizing that the return of the HIF presented significant challenges, given its magnitude and, therefore, as discussed previously, we invested our 2017 outperformance and made significant strides in administrative spend productivity to fund this benefit design for our customers.

We believe that balancing growth and margin are paramount, and it was essential after two years of stagnant membership growth, in no small part attributable to the Aetna transaction, to drive our top line in a disciplined fashion that would enable us to achieve our EPS growth targets of 11% to 15% over the medium and longer term.

In this process, we have also strengthened our relationships and enhanced our partnership with the external brokerage community, who, along with our outstanding MarketPoint career sales organization, allows us to achieve this objective.

Based on what we know today, achieving individual MA membership growth in the neighborhood of 150,000 to 180,000 lives is a reasonable estimate.

And while there are scenarios that could certainly reduce that number, including a sales slowdown for the remainder of AEP, there are also factors that could increase it, including greater-than-expected retention of existing members and higher post-AEP sales figures than are currently forecasted.

It is important to note that data on member retention is very limited at this point. I would also like to comment briefly on our forecast for group MA membership.

Based on what we know today, which is significantly more certain than individual MA given the timing of the pricing cycle, we estimate membership growth to be comfortably in the low-double digits on a percentage basis for 2018.

This achievement will be the second consecutive year of double-digit percentage increases in a highly competitive business, particularly for jumbo accounts, where we have committed to remaining disciplined with our pricing. While we were pleased with our estimated growth in MA, there is some pressure in the competitive stand-alone PDP space for 2018.

As you are likely aware, Humana offers three PDP plans, including a Basic Plan that serves, among others, our low-income members, an Enhanced Plan and a low-priced Walmart Plan, whose extraordinary growth has made us the leading individual PDP carrier in the country.

With regard to the Basic Plan, we priced to breakeven contribution margin at a regional level. In Florida and South Carolina, our bid proved to be priced over the benchmark, which we anticipated, resulting in the loss of our auto-assigned low-income members in those states.

Additionally, our Enhanced Plan continues to lose members each year, but historically this has been more than offset by the significant growth in our Walmart Plan. This year, however, the Walmart Plan is no longer the low-price plan in a number of markets, as other carriers have priced more aggressively.

And as a consequence, while we will still grow that Plan, it will likely be at a materially lower rate. Collectively, therefore, we expect that our overall PDP business will decline by a few hundred thousand members.

While the impact on PDP insurance profitability will not be meaningful, we expect the lower Walmart Plan growth will impact the growth of our Pharmacy business, given the industry-leading mail order rates in this plan. I will now turn to making a few high-level comments regarding our projected 2018 financial performance.

As we've discussed previously, Medicare Advantage membership growth drives top-line revenue growth that is a critical component of our long-term EPS trajectory.

Recall that MA membership growth not only benefits the health plans, but also feeds our Healthcare Services segment, as our members engage with us in our Pharmacy, Home Care and Provider businesses. Moreover, we are able to achieve increased scale with our administrative spend as the top line increases, which helps drive the bottom line over time.

From a profitability perspective, I have already highlighted the return of the HIF, which for overall Humana is a non-deductible fee in the neighborhood of $1 billion, as well as the impact of lower PDP growth on our Pharmacy business as meaningful headwinds toward our 2018 performance.

It is also important to note that we will not assume that our mail order rate in the Walmart Plan, while still very high, will recover from the lower levels of mail order usage that we have seen this year, particularly among the new members who joined us in 2017 and any members who select this Plan for 2018.

Our Provider business also continues to face significant rate pressures in South Florida. Additionally, the Group and Specialty segment will have a timing headwind associated with the HIF due to the timing differences that result from group renewals that are not on a calendar-year basis.

And finally, there are certain stranded costs that result from our exit of the Individual Commercial business on January 1, 2018. Together, the HIF timing issue and Individual business stranded costs represent a headwind of approximately $0.30.

We expect to offset these headwinds through the productivity initiatives described above and capital deployment, both through share repurchase and M&A.

It is important to recall that the impact of new Medicare Advantage members on profitability is relatively muted in the initial year before they are documented appropriately for the risk we are taking and are engaged in our clinical programs. Turning now to EPS.

Recall that on last quarter's call, we discussed the need to begin with a baseline adjusted EPS of approximately $11, which is largely unchanged. It is also important to note that we have achieved EPS growth well in excess of our long-term range over the last several years.

Additionally, we would anticipate guiding to a slightly wider range than we did in 2017, which should be more in line with historical practice, given our anticipated greater MA growth in 2018 versus 2017, which can create slightly more uncertainty in our earnings forecasts.

Finally, we would expect that the high end of our initial guidance range will be a bit below our long-term target of 11% to 15% growth, with our individual MA margin guide slightly below our 4.5% to 5% range.

This reflects the significant headwinds that I've articulated and the importance of offering a compelling value proposition to our customers while continuing to invest in the build-out of our Integrated Care Delivery model that will create long-term sustainability.

Consistent with our historical practice, our 2018 initial guidance will assume a normalized rate of favorable prior-period development for our Retail segment, which exceeded expectations in 2017, while assuming no favorable prior-period development for our Group and Specialty segment.

Finally, I would like to briefly discuss the recently announced deal to sell our non-strategic closed block of Long Term Care Insurance business. Upon consummation, we will have no remaining exposure to this business, where we have seen significant reserve strengthening over the last number of years.

Based on the terms of the agreement, the transaction is expected to result in an estimated GAAP loss on sale of approximately $400 million, or $2.75 EPS, which includes some non-cash charges.

That said, we do anticipate a net positive economic benefit for Humana as the $203 million of parent company cash contributed into the subsidiary, together with the transfer of approximately $150 million of statutory capital with the sale, should be more than offset by the estimated $500 million of cash savings associated with the expected tax treatment of the sale.

We anticipate the transaction will close by the third quarter of 2018 subject to customary closing conditions, including regulatory approvals. Excluding the loss on sale, the company does not anticipate a material impact to earnings in 2017 or 2018 from the sale of the business. With that, we'll open the lines up for your questions.

In fairness to those waiting in the queue, we ask that you limit yourself to one question. Operator, please introduce the first caller..

Your first question comes from Peter Costa with Wells Fargo Securities..

Good morning. Thank you. I'd like to understand a little bit more about why the change in the way you're giving 2018 guidance this time as opposed to giving more detail on a straight-up EPS number. And also, your expectations for Medicare Advantage growth next year, given the increased competition we're seeing from others in the marketplace.

Why do you believe you're going to see better growth there?.

Sure. Good morning, Peter. On the guidance side, we didn't actually give guidance of the third quarter last year either. What we're trying to give investors a broad direction of what we see 2018 to be.

But there are still a lot of things that are going to happen in the next few months and we think it's appropriate and prudent to give guidance on the fourth quarter call, and that will be our practice going forward.

With regard to individual MA growth, really the reasons that I discussed in my opening remarks relating to the stability of benefits that we provided for our members and investing in certain markets where we believed we had a high right to win.

And as we think about our value proposition and as we see the competitive data, we feel good about the range that we provided this morning..

Thank you..

Your next question is from Kevin Fischbeck with Bank of America Merrill Lynch..

Great. Thanks. I guess I wanted to go back and make sure I understood what the commentary was around the EPS guidance for next year.

Did you say that you're going to guide below the range of 11% to 15%, or below the midpoint of that range? And I guess when we think about the rationale for doing below that this year, would we think that there's anything unusual into 2019 that should stop you from getting to that long-term target?.

Sure. So, with regard to the range, what we said was, our initial guide at the high point will be a bit below our 11% to 15% range. So a bit below 11%, so it's not below the midpoint. It would be way too early to comment on 2019 since we haven't given 2018 guidance.

The only thing I would say is that, given the HIF return in 2018, that's a particularly large headwind that we've had to deal with. I mean, a $1 billion non-deductible fee is a very big number. And so that's been a major issue that we've had to grapple with and it really affects our customers and affects our earnings performance..

Okay.

Next question?.

Your next question is from Justin Lake with Wolfe Research..

Thanks. Good morning. Just questions on Medicare Advantage and the outlook there.

First, can you talk to the rationale between not being able to guide to a target margin at 4.5% to 5%, given how strong the business was this year? And specifically, you said, Brian, I think during the prepared remarks that cost trends are running better than what you built into the bids.

Does this guidance, that lower than 4.5%, assume the bid margin or does it assume inclusive of a lower trend? And lastly, can you just tell us what kind of attrition rate you're assuming for this year and how that compare for 2018 and how that compares to previous years in Individual MA? Thanks..

Okay. Good morning, Justin. That was three questions..

Indeed..

Okay. Again, we've invested our outperformance in 2017 into the product design, which gets us to below that 4.5% to 5%. And that's really what's driving it. Again, we're facing very significant headwinds, as I've mentioned a few times with the HIF.

We've I think done a good job of offsetting a lot of that headwind with very significant productivity savings that we've been very focused on and driving in 2017. I think you'll see that ultimately in our 2018 guidance. But that's really the rationale for driving below the initial targeted range of 4.5% to 5%.

I'm trying to remember now the second question. Justin, remind me the second question..

You'd said there was better trend..

Sorry, right. So to be clear. Sorry about that. So, on the trends side, what I was referring to was the Commercial business trend. Trends continue to run favorable to pricing. But consistent with where we were really last quarter when we gave the updated guidance, nothing has really materially changed from what we saw last quarter.

But on the Commercial side, we have seen continued lower trends and that's why we were able to improve our pre-tax guidance. And, again, I really wouldn't want to comment too much on attrition embedded in our numbers. I would say that we feel very good about our attrition levels. I'm just not going to comment at this point.

It's way too early to give a sense of where attrition will be..

Thanks..

No problem..

Your next question is from Matt Borsch with BMO Capital..

Not to belabor the point again, but on your 2018 guidance, can you just talk to how maybe your view evolved over the last few months relative to how you described the outlook on the second quarter call?.

I would say, Matt, it's really consistent. I think the business continues to perform quite well. We feel good about all the initiatives that we're pursuing. We made the decision at bid time to invest the outperformance into our 2018 product design. We believe that was the right decision to create long-term sustainability.

We also believe it's important to continue to invest in the business, which is what Bruce and I have talked about in our remarks. And so we're going to continue to do that. But I would say that nothing has really materially changed in our business outlook from this quarter from last quarter..

Okay. And if I could just one more, which is on the Medicare Advantage growth.

How does your very preliminary view of the Open Enrollment process compare with what I understand to be CMS' prediction for 9% overall growth in program-wide enrollment, which I guess would include both Individual and Group?.

It's really hard to comment on how CMS calculates the numbers. I would tell you that what we've seen the last two years on the Individual side is a little bit less than 6% growth. For us, that's not an unreasonable way to think about market growth this year. But, obviously, we'll see where the data shakes out.

But there's nothing that's meaningfully changed this year that would change that growth rate..

All right. Thank you..

Your next question is from Josh Raskin with Nephron Research..

Thanks. Good morning. Question is around the reductions in force and the voluntary retirement. And I'm just curious what the catalyst was there.

Was there some sort of strategic review process? Was this sort of just, hey, post the Aetna transaction, we've got to start thinking about the business in a longer-term fashion? I'm just curious what created that.

And was any of that tied to the MA bidding and the inability to get into that 4.5% to 5% range?.

Really throughout 2017, we have been oriented to improving the productivity of the organization. And it's really to create capacity, both to be competitive in the marketplace from a benefit design point of view for our customers.

And, as everyone knows, there's a continued need to invest in the business for long-term competitive positioning, whether it's in technology or it's in areas that are building capabilities, like in our Provider area or even in our Home area, which helps us with clinical outcomes.

So I wouldn't say it was really a planned process that we went through over the year. It came together at the end and the last month or so. But I would say that we've been working on these productivity initiatives really even before the Aetna transactional termination.

And so, I wouldn't call it anything but just continuously trying to improve the productivity of the organization and reinvesting those dollars in our customer and reinvesting those dollars in the infrastructure of the company..

All right. That makes sense. And just, Brian, real quick follow-up. I just want to make sure I understood.

The starting point is $11 in terms of a run rate for this year, and that's the number from which you'll grow the high end slightly less than – or a bit less than 11%? Is that the right math?.

That's correct..

Okay. Perfect..

Yeah..

Your next question is from Ana Gupte with Leerink Partners..

Yeah. Hi. Thanks. Good morning. The first question on the workforce reduction.

What is the timing of realizing the run rate savings? Or is all of that termination happening by the end of this year?.

We have notified the majority of the individuals. So, first, let me back up, Ana, a little bit. As I mentioned, we've been doing this throughout the year. So, we've had reductions that have begun to show up in our financial numbers probably starting in the second quarter or so.

But this particular reduction will show up in the first quarter of 2018 as we transition the individuals out. The full transition would be done by the middle of January..

Okay. Thanks. And then if I could just do a quick follow-up.

On the Physician Services, how do you not double count that pressure on your Medicare MLR outlook? And will that persist into 2018, or is that kind of done at this point? Because that's related to the rates in MA, correct?.

When you say Physician, do you mean our Provider business in South Florida, is that you're referring to?.

Yeah, right. Yeah..

Okay. Yeah. I mean, look, it's an interesting dynamic in South Florida. Those rates have continued to be ratcheted down over the last few years. We've seen that multiple years in a row. I would tell you to-date that the competition really hasn't changed fundamentally the benefit design there.

And so, as a consequence, I think people have just had to get better and better to continue to drive profitability. But there's no doubt that profitability has been reduced in the Provider segment because of those actions.

We've also adjusted some of our contractual terms with our providers to help ease that transition and been very thoughtful about our benefit design and working with our provider partners. But net-net, it has had an impact on our overall profitability in that region in the Provider business.

As it relates to growth, as I said, I think the carriers and us included, I think have tried to be very prudent about how we deal with these rate declines and still offer compelling value proposition to members. And that's allowed us to continue to grow. I would tell you that were it not for those rate reductions, we would grow more.

There's no doubt about it. But we've done everything we can to try to minimize the impact on the customer..

Thanks for the color..

Your next question is from A. J. Rice with Credit Suisse..

Hi. Hello, everybody. Just a point of clarification to Josh's question and then I want to ask you about Pharmacy. On the $11 base earnings, you commented, Brian, that you would guide differently than what your actual PYD was this year. Is that reflected in the $11 baseline start? And then more broadly, on your Pharmacy comments.

You've been able to drill down as to what's happening in mail order. And I know you guys did a strategic review of Pharmacy a few years ago, but there seems to be a whole lot of changes in the PBM landscape. Does that cause you to look at anything differently, partnerships, opportunities? And then your push for integrated models.

I know guys are talking about engaging with the pharmacists more. And at the Retail pharmacy outlet, you have your relationship with Walmart.

Is there any evolution in how you're deploying that in terms of maybe provision of care in dealing with gaps in care?.

Good morning, A. J. So, on the $11, what the $11 reflects is the 2017 outperformance. So effectively what that does is it takes into account the PPD for 2017 as we start our baseline. But as you think about 2018, when we grow off that $11 base, we're not going to assume the same level of PPD that's occurred.

So that's the distinction we make between the 2017 PPD that's effectively reflected. That outperformance is reflected in taking the baseline back to $11, but the 2018 guide will not assume the same level of PPD that we've seen in 2017. So hopefully that makes sense..

Okay..

On the mail order side, I would separate the mail order reduction we've seen and some of the broader questions that you're asking. It's hard to know exactly what's driving the mail order reduction, particularly for the new members. We think it might have something to do with benefit design.

It could have something to do with just the nature of the risk that we're attracting versus the competition and where perhaps the higher utilizers are going. I think overall we're benefiting from a health plan perspective in terms of the risk dynamic we're seeing, but it has had an impact on the Pharmacy profitability.

More broadly to your question on strategic reviews and costs. We constantly are looking for opportunities to drive costs out of the system. We continually review our cost of goods. We continue to look at our cost to fill.

And I will tell you that the Pharmacy team really does a fantastic job of being best-in-class in both of those areas as we look at the opportunities that are out there. But as we've said multiple times, we are not wedded to any particular philosophy with regard to if we can find opportunities to drive out costs the system, we will do that.

But what's critical for us is that the Pharmacy is a critical clinical engagement opportunity and mechanism with our members. And so that can't change. But as it relates to costs, we are always open-minded. And I will tell you, these guys do a great job of driving best-in-class cost of goods for our plan and for the Pharmacy..

A.J., you did further ask the question around leveraging pharmacists and the ability to close gaps. We do think that pharmacists serve an important role in the clinical interaction with our members.

And then today, in fact, we have quality contracts with a number of retail chains that allow that benefit to both encouraged pharmacists at the counter to do it and in addition to get rewarded for any kind of improvement in quality and clinical outcomes.

In addition, we are continuously adding pharmacy locations to our provider areas where we will have a pharmacy inside our Primary Care Clinics. And again, it's leveraging that moment of influence that the pharmacist has. We are finding mixed results in our relationships with the retail pharmacies.

In the clinical outcomes, we find where it's convenient and it's more in a clinical setting, it's more effective than it is in the retail setting. But I think that's also just the time that the pharmacist has at the counter to be able to have that engagement..

All right. Great. Thanks a lot..

Your next question is from Chris Rigg with Deutsche Bank..

Good morning. Just wanted to ask a big picture question about the competitive environment in the Medicare Advantage business. Seems like you guys are working really hard to get to market growth, albeit at a target margin slightly below where you want to be long term.

Do you think other participants are being a little bit more aggressive or slightly irrational in their attempts to grow membership at this point? Thanks..

I don't know if I'd use the word irrational. But I think it's fair to say that our competitors view Medicare Advantage as an exciting growth area. I think they've invested a lot to grow their platforms and to expand their positions across the board, and it's just something that we're going to have to deal with.

I think we feel good that we are really in the Strike Zone of where the growth of Managed Care is happening. We believe that we have superior clinical programs and the right operating model to capitalize on that growth. But there's no doubt that we're facing a much stronger competitive environment.

And I would say that's been compounded by the fact that we have this massive Health Insurance Fee that's returning in 2018. That impacts the customer and it impacts the industry.

And so, I think those two factors have required us to take significant action, which we've done this year, and invest some of the outperformance that we've had this year into our 2018 benefit design. But long term, I will tell you we feel very good about how we're positioned..

I would just add to that. I think as you look at the trajectory of the industry, it has a very strong demand trajectory. But I would also say that I think even on our investments we're making today that the competitive nature is going to evolve.

And we think the competitive nature is going to continue to evolve to be much more oriented to a clinical approach as opposed to just from an insurance and pricing point of view. And as you look at our investments, it's really focused on how do we continuously proactively help people with, especially chronic members, in managing their conditions.

And I think long term, all organizations to be in this business are going to have to have some really clinical strength. And we believe in the short run, we have to meet the competitive natures of pricing relative to the number of players being in the marketplace. But long term, we have to invest and build those clinical outcomes.

And it's the combination of those two things you see the organization doing..

Great. Thanks a lot..

Your next question is from Gary Taylor, JPMorgan..

Hi. Good morning. Just had one clarification and then my question. And to be awfully redundant on the clarification, I just want make sure I have this perfectly correct. So, if we start 2017 base of 11%, we're going to grow a little below 11% to 15%, 11% growth will be $12.21, so something a bit below that.

And you're going to give a wider range than the initial $0.30 range.

Is that fair?.

Yeah. Without opining on the $12.21, yes, that is correct..

Okay. And then just going back to the early retirement and the layoffs announced. I wanted to make sure I had Bruce's comments correct that you expect most of that to be effective in January, so you get a full year earnings benefit from that.

Did I understand that correctly?.

You did, yes..

And can you give us a dollar amount that you're targeting? And then does most of that just come out of G&A?.

I would say – so, these are big numbers. Ultimately, at the end of the day, our savings initiatives will run into the hundreds of millions of dollars for 2018. And I would say some of that is in G&A. Some of that will show up actually in our MER because of the nature of the associate base that's being impacted.

That actually gets classified as an MER expense. I think it's fair to say that when you look at our adjusted operating cost ratio next year, when you pull out the HIF and other things that you will see a reduction for sure. And we'll obviously give more color on that on the fourth quarter call..

Okay. Thank you..

Your next question is from Dave Windley with Jefferies..

Hi there. It's Dave Styblo in for Windley. I wanted to just come back to the HIF so I can understand a little bit more specifically what parts of the business does it affect? I'd imagine maybe some of it is for exchange support.

But can you give us a better sense of what departments these are coming in? And to what extent the savings are going to be used to offset the HIF, or is this going to be used to invest in initiatives you outlined in the prepared remarks about care in the home or the providers?.

Yeah, I'll take that. I think it really is across the organization. There wasn't one area that was impacted both geographically or from a department point of view the organization. Really, as Brian has mentioned, is we're looking for productivity improvements throughout the company.

So, I wouldn't say it's one specific area related to any one initiative we have. In regards to the investment side, is it investing, is it going to the shareholders or is it going to benefits? I would say it's fairly, it's fungible and it sort of goes through all that.

I think we've continued to manage in how do we invest in the business for long-term sustainability and compete in the local marketplace, how do we continue to have a competitive market offering. And if you look at our market offering, you'll see that we're not the cheapest in the market.

So we're constantly trying to ensure that we're not giving the product away and our brand and all the things we do from a customer experience point of view wins the customer over. And then at the same time, we also look at the ability to invest in the advancement of our initiatives. And I would say it's sort of all those items.

I wouldn't say we did it just to fund a particular initiative. We really worked through saying, how can we be competitive? How can we meet the long-term goals of our shareholders? And, at the same time, how do we ensure that we are productive in being able to also invest..

Okay.

And then as you're looking to reduce some of these costs, how do we get a little bit more comfortable from the outside that these don't impact your ability to move forward on trend benders?.

Yeah, I would tell you that we cherish the trend bender area. And I would tell you a lot of what we've done is to look at where are the areas that are less where it is not as impactful. But the trend bender area is a very important part.

And as you can tell from the script that I outlined, we are investing in the areas that we feel will affect the chronic conditions and really bring alive longer term-trend benders. And so investors should not worry about that. That is a passion of ours that is continuing to ensure that our clinical programs our advanced..

Next question, please?.

Your next question is from Zack Sopcak with Morgan Stanley..

Hey. Thank you for the question. Can you just remind us what's included in that preliminary 2018 guidance, what the contribution of capital deployment is? And then you talked about some potential opportunities for M&A.

But how do you view M&A versus share buybacks as we head into next year?.

At this stage, we're not prepared to talk about the specifics around capital deployment. I think you've seen our willingness to deploy capital in buying back stock, and we will continue to do that. And similarly, on the M&A side, it's really not something that we're prepared to give any more color around today.

Although then, just referring back to Bruce's opening remarks that we actively look for assets that advance our strategy. And we're going to continue to do that because it's important to do that.

I would tell you that if we found an M&A opportunity that advanced our strategy, that would take precedence over share repurchase if it made sense to do that. But we're very committed to share repurchase. You see that we have leverage capacity in our balance sheet. We're at 30%, 31% debt-to-cap.

We have ample parent company cash to accomplish our objectives. And so we won't be shy about deploying our capital, obviously maintaining our investment-grade rating, which is also very important to us..

Okay. Thanks.

Just to clarify, when you give full guidance, I guess, in the fourth quarter, will we get more color on how much of that is coming from capital deployment?.

Yeah, we typically in our guidance waterfalls, we'll call out for you exactly what relates to capital deployment. So, yes, we will do that..

Okay. Great. Thank you..

Your next question is from Sarah James with Piper Jaffray..

Thank you. I appreciate the detail on analytics and data sources.

Can you tell us how you're using that data? Is it on the Care Management to Clinical side? Or are you also following it into decisions on branding spend, marketing mix and product development? Then do you feel that you have the technology and human assets that you need for your analytics? Or should we expect Humana to get more competitive and more prudent data scientists?.

We have multiple sources of information, both clinically, which are coming from claims based to electronic medical records information, which also includes coming from notes within the Electronic Medical Records. So, you see that one side.

But on the other side, we also pull a significant amount of consumer information, both from as much we can get from public, but also in the interactions that we have with our members.

So we look at how they're using the digital, from the Pharmacy point of view, what are the using the Pharmacy area, how they're using or are they using mail-order, are they using our Retail? And that gives us a lot of information about how their preferences on engaging in their healthcare.

And so, I would say that there's a whole host of ways we go about bringing the analytics to the forefront.

In regards to the question on analytics and from a human resource point of view, we have over the last number of years, and we really haven't brought it out to our investors, have invested significantly, both in the Consumer Analytics and also in our Clinical Analytics.

And I think people would be very surprised at the depth of our analytics capability today. We're always adding and expanding our clinical capability. It's just part of our normal planning cycle and our HR recruitment area. And so, I would say that, yes, to answer your question, that we will continue to be investing in that area.

But I would say today, we are in this area of predictive analytics and contextualization of the member, I would say we're fairly advanced in both from our competitive point of view, but I think in the industry in general..

You said that you would be surprised at how much Humana has invested in Consumer Analytics.

Is there any way for you to frame that up or size it for us?.

I don't think I would do that. I think both from a competitive point of view and in addition we don't disclose that kind of detail..

Thank you..

Your final question comes from Christine Arnold with Cowen..

Thanks for squeezing me in. A couple things. Healthcare Services, I hear that we still have some headwinds here. But also, I'm hearing that MA fees in the Healthcare Services – is Healthcare Services a headwind or a tailwind next year with respect to earnings? And then good growth in group MA.

But we're hearing that it's a pretty competitive environment there. Do you expect the margins there to come in kind of below your target range of 4.5% to 5% as you do with Individual, or do you expect margins to be maintained there? Thanks..

Morning, Christine. So, I'm not prepared to comment on giving Individual segment guidance. I think there are pluses and minuses on the Healthcare Service side. Obviously, you mentioned MA growth. That's obviously a positive. I've talked about some of headwinds on the Pharmacy side with regard to PDP growth, et cetera.

So, I'm not prepared really to give segment-level specific guidance at this time. But obviously, we'll comment extensively on that on the fourth quarter call. With regard to group MA, we've been very clear that we're going to maintain pricing discipline on that. As we've said before, our margins in group MA are not 4.5% to 5%.

That is not a target margin Group MA. It is below that. But I think we feel pretty good about our Group MA business. I think the team is doing a really nice job of finding opportunities where we can earn a good return on capital.

And again, being very disciplined in some of these larger accounts where we can drive profitability as well as customer satisfaction. So, I think we feel very good about the positioning of our Group business..

So, on the margin, is the margin a headwind or a tailwind do you think for Group MA next year?.

Again, I'd rather not give – I'm sorry?.

Is it easier to pass the HIF along because you're dealing with a group?.

Typically, in the larger accounts that there's a specific adjustment for the HIF, particularly the jumbo accounts. But that obviously impacts overall growth in the space, but also potential willingness of a Group account to actually choose Group MA. So, there's some impact there.

But it is, I would call it, a very transparent market, particularly at the large end. And so, the HIF is well known and it's discussed..

Okay. Thanks..

Thank you..

I will now turn the call back over to Bruce Broussard for closing remarks..

Well, thank you. And, again, thanks to all our investors that support the organization over the years. You've been part of us. And lastly and as importantly, I'd like to thank our talented Humana team members, which really make these results possible. And so, we appreciate it. And this will be the close of the call. Thank you..

This concludes today's conference call. You may now disconnect..