Juan José Orellana - Molina Healthcare, Inc. Joseph Mario Molina, MD - Molina Healthcare, Inc. John C. Molina, JD - Molina Healthcare, Inc. Joseph W. White - Molina Healthcare, Inc..

A.J. Rice - UBS Securities LLC Kevin Mark Fischbeck - Bank of America Merrill Lynch David Anthony Styblo - Jefferies LLC Sarah E. James - Piper Jaffray & Co. Ana A. Gupte - Leerink Partners LLC Gary P. Taylor - JPMorgan Securities LLC Thomas Carroll - Stifel, Nicolaus & Co., Inc..

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare Fourth Quarter and Year-End 2016 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded Wednesday, February 15, 2017.

I will now turn the conference over to Juan José Orellana, SVP of Investors Relations. Please go ahead, sir..

Thank you, George. Hello, everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the fourth quarter and fiscal year ended December 31, 2016.

The company issued its earnings release reporting these results today after the market closed, and this release is now posted for viewing on our company website. On the call with me today are Dr. Mario Molina, our CEO; John Molina, our CFO; Terry Bayer, our COO; and Joseph White, our Chief Accounting Officer.

After the completion of our prepared remarks, we will open the call to take your questions. If you've multiple questions, we ask that you get back in the queue, so that others can have an opportunity to ask their questions. As a reminder, we will be discussing the company's outlook for 2017 tomorrow during our Investor Day presentation.

Today, we will only be taking questions on our earnings release related to 2016. Additionally, our comments today will contain forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act.

All of our forward-looking statements are based on our current expectations and assumptions, which are subject to numerous risk factors that could cause our actual results to differ materially.

A description of such risk factors can be found in our earnings release, and in our reports filed with the Securities and Exchange Commission, including our Form 10-K Annual Report, our Form 10-Q Quarterly Reports, and our Form 8-K Current Reports.

These reports can be accessed under the Investor Relations tab of our company website or on the SEC's website. All forward-looking statements made during today's call represent our judgment as of February 15, 2017, and we disclaim any obligation to update such statements, except as required by securities laws.

This call is being recorded and a 30-day replay of the conference call will be available at our company's website, molinahealthcare.com. I would now like to turn the call over to Dr. Mario Molina..

number one, normal membership attrition; two, the addition of higher cost members through the special enrollment process; three, higher cost, as members reach the limits of the cost-sharing provisions of their coverage; and four, increasing utilization, as members become more engaged with our care networks.

John will go into more detail in a minute, but I want to point out that the financial impact of the last three of these items was more pervasive in the fourth quarter than we had expected. Those developments not only reduced fourth quarter performance, but also led us take a closer look at our 2017 pricing.

As a result, we recorded a $30 million premium deficiency reserve in the fourth quarter. I noted earlier that our management team has identified the Marketplace challenges and remains focused on taking action to address them quickly and efficiently.

We have therefore increased our Marketplace premium rates between 6% and 37% across all of our markets, resulting in an average of about 15%. And we'll continue to advocate for policies that stabilize the marketplace.

With that said, and recognizing that we are one of the nation's largest marketplace providers, we believe there are simply too many unknowns with the Marketplace program to commit to our participation beyond 2017.

We will wait and see how the new administration and Congress will adjust the program, and we plan to evaluate our participation on a state-by-state basis. On another front, we are disappointed by the court ruling last month, which blocked the merger Aetna and Humana.

And while Aetna and Humana have terminated their transaction and consequently their divestiture transaction of Medicare assets to Molina, we remain committed to growing our Medicare Advantage program. We intend to build on the experience we have developed in delivering quality healthcare to nearly 100,000 Medicare beneficiaries in 11 states.

And we wish Aetna and Humana the best of luck. Our company has always been committed to seeing that each of our plans is measured for quality by the National Committee for Quality Assurance. Why does quality matter and why is quality important? There are two important financial reasons.

First, a growing number of states are tying reimbursement and patient assignment to quality scores. And second, Medicare links quality scores to our premium rates. We're proud that all of our eligible health plans, 11 in total, have been accredited by the National Committee for Quality Assurance.

Furthermore, nine of our health plans have been accredited for Marketplace. Finally, our plans in New Mexico, Utah and Washington were top rated Medicaid health plans in their states. We're proud of our continued success as we work to deliver the highest quality care to the population we've served for the last 36 years.

All of our eligible health plans maintained or increased their star ratings for Medicare. Furthermore, our Michigan health plan was the highest rated plan among Medicare Special Needs Plans for dual-eligible beneficiaries; and our New Mexico health plan earned four stars.

Despite the difficulties we encountered in 2016, we are looking forward to improvement in 2017. As has been our practice, we will reserve our comments on our outlook for 2017 for Investor Day tomorrow. I would now like to turn the call over to John..

normal membership attrition, the addition of higher cost members in the special enrollment process, higher cost as members reached the limits of the cost sharing provisions of the coverage; and increasing utilization as members become more engaged with our care networks.

Throughout the fourth quarter, all of these trends except the first, that is normal member attrition, were more pronounced than we had expected. First, the number of members enrolled in the special enrollment process increased by an unexpectedly large amount in the fourth quarter.

Because these members bring with them pent-up demand and lower risks scores, they're a drag on profitability compared to those joining us to the normal annual enrollment period. It has been well documented that SEP members come in with higher costs.

Specifically, we estimate that the average medical care ratio for those SEP members that enrolled during the fourth quarter of 2016 was 185%.

Increased utilization driven by special enrollment membership was compounded by higher pharmacy cost at the number of prescriptions filled by our members, especially early refills, increased during the month of December. Per-member per-month pharmacy cost increased by approximately 10% over the November run rate.

Whether these developments were a result of patients being worried about losing their coverage after the November elections, we don't know. But there is no doubt that these developments put pressure on our fourth quarter results.

The increasing costs borne by Molina, as members reached the limits of cost-sharing provisions of their coverage, was also a factor in our poor fourth quarter performance. The share of total member pharmacy costs borne by the company, for example, increased from 82% in January of 2016 to 88% by December.

Marketplace medical cost trend was 4% for the year, but the per-member per-month costs spiked in December. Of course, the risk corridor program of the Affordable Care Act was designed to partially mitigate the damages of situations like ours.

As all of you know, the federal government has not met its obligations under the risk corridor program, and we have not recognized any benefit from this program in the results we are sharing today. Nevertheless, we are pursuing collection of the amounts due us as part of that program.

To support our belief that we're entitled to the risk corridor payments, consider that Judge Thomas Wheeler recently ruled that the federal government is liable to Moda Health for all unpaid risk corridor payments. This gives Molina reason for optimism as the facts in our lawsuit are similar to those in the Moda Health case.

The $140 million owed to Molina for risk corridor payments, if realized, would give a truer picture of the financial results of the Marketplace program. Leaving the Marketplace and looking at our business as a whole, our total premium revenue for the year was up 23% from 2015 with year-over-year increases in all programs.

It's important to note that nearly 75% of all new premium revenue came from programs other than the Marketplace. I want to emphasize that margins in our TANF, ABD and Medicare programs improved in 2016 over 2015.

To put it another way, our traditional business lines of Medicaid and Medicare are improving, despite the deterioration we experienced in Marketplace. Our management of administrative expenses also improved in 2016. Our general and administrative expense ratio decreased to 7.9% for the full year 2016 compared to 8.1% in 2015.

Finally, at December 31, 2016, days and claims payable was flat sequentially at 47 days. And the company had cash and investments of nearly $4.6 billion, including an excess of $260 million at the parent company.

As disclosed Tuesday, the termination of our purchase agreements with Aetna and Humana will result in a $75 million breakup fee, which we will recognize in the first quarter of 2017. As a reminder, we will be hosting our Investor Day conference in New York City tomorrow, Thursday, February 16, at 12:30 PM Eastern Time.

At that presentation, we will be discussing the company's outlook and strategy for 2017. We look forward to seeing you there. If you're not able to attend in person, we encourage you to join the webcast. This concludes our prepared remarks.

We are now ready to take questions on the quarter and the year, but we'll save questions on our outlook for tomorrow's call..

Our first question comes from the line of A.J. Rice with UBS. Please go ahead with your question..

Thanks. Hello, everybody. I'm sure there'll be plenty of discussion about the Marketplace, but I thought I might ask you about some of the other states that you're flagging here.

It sounds like more on the Medicaid side, I think you're flagging Ohio which it look like was an issue early in the year, but it sounds like that was turning around, and now, it sounds like the MLR increased 310 basis points.

Can you tell us what's going on with that? Any update on – maybe a little more flavor on Puerto Rico? And then, Texas is one you've talked about but it didn't – wasn't flagged today.

Any update on what you're seeing there?.

Sure, A.J. So, on the Medicaid side, we did talk about Ohio early in the year. The first quarter was a bit rocky for us. And then, we were able to bring the medical cost down in Q2 and Q3. I think that in Q4, it's just normal seasonality as opposed to anything else.

In Puerto Rico, we did again flag that early in the year, and have had some very good results in improving the profitability of the Puerto Rico plan. Texas, again, we cited early, but the Texas issues again are largely behind us..

Okay. Thanks a lot..

Our next question comes from the line of Kevin Fischbeck with Bank of America Merrill Lynch. Please go ahead with your question..

Great. Thanks. I guess with the exchange business, if you could go into the little detail about the other items. I guess, there was a $35 million favorable number. What was that related to? And then, I think you said that you would look at exchange in a state-by-state basis.

Are there any state exchange products that were profitable in 2016?.

Hi. It's Joe speaking. To your first question, that $35 million variance from pricing is a combination of things. It's lower admin costs than we anticipated plus a little bit more revenue around some other aspects of the program, in total, it added up to about $35 million.

Regarding the individual state performance, we don't normally give that, but I can speak to Texas particularly as being a state where we're doing relatively well on the Marketplace program. We feel really good about Texas. Florida is hanging in there. California hanging in there. So there's three states..

Okay. Actually, just to clarify that, SG&A will be a little bit lower. The number – is that like a bonus accrual? Like earlier we had like Anthem report worse numbers..

Oh, no. It's just about the usual things, commissions, just allocation of admin costs, things like that..

Okay. All right. Great. Thanks..

Our next question comes from the line of Dave Styblo with Jefferies. Please go ahead with your question..

Sure. Thanks for taking (26:27) the questions. Maybe just to circle back to the exchange and then understand better the pressure, it looks like there's about $1.20 of pressure in full year 2016. Is that sort of the right way to think about it? At the end of the day, you were not able to participate and ultimately had to exit.

Is that earnings release that we would think about on 2016 or are there some other puts and takes? And also, I'd like to ask about perhaps any negative SG&A leverage that might be associated with that..

Sure, Dave. I want to be careful, because when you ask what would happen if we got out, we're beginning to get into forward-looking guidance type of things. But the way that you described – the way I would say, the puts and takes for Marketplace, it really relates to the risk transfer.

If you look at that, we ended up transferring $350 million in excess of what we priced it at. Now, if the risk transfer methodology were structured in a more accurate way, you would expect almost a one for one decrease in medical expenses, idea being you would have helped your members, so their costs would be lower.

But in fact, our costs were only $120 million lower than pricing. So that differential really speaks to where the miss comes in the Marketplace..

Okay. And then, on a CMS release today, they talked about some of the exchange rules, and I didn't get a chance to fully look through that being on the road today.

Was there anything in there that really meaningfully will help you on that? I don't think I saw on the quick headlines there was anything on the risk adjusters there, but curious to hear your takes and thoughts about rules around Special Enrollment Period, and what they did right, and got right that should help you versus what else you need besides what you've discussed earlier about the risk transfers?.

Hi. This is Mario. We're going to discuss that tomorrow during our outlook discussion. But I do think it is a positive step, but it's not going to solve the really big issue that we have which is risk transfer. It addresses a number of other things and we'll go over those tomorrow..

Thanks..

Our next question comes from the line of Sarah James with Piper Jaffray. Please go ahead with your question..

Thank you. I realize that HIQ (29:17) is fluid, so I'd rather focus on the core. You've been talking about high acuity numbers, ABD and MMP contracts continuing to mature towards a run rate in 2016. And if I look at the timing of contract wins that make sense, I can see an absolute improvement on year-over-year MLR, but I'm wondering about the pace.

So is MLR on the new high acuity membership, I guess, those gained over the last, call it, two years or so, both ABD and MMP improving at the pace that you would have expected? How long do you think is the path to normal margins on that book? And do you still think that ABD and MMP is 1.5% to 2% net margin business?.

That's a great question, Sarah. I would say that we are progressing along the plane that we wanted to for the higher acuity members. We did have a bit of a hiccup, for example, in Washington, when we rolled out the integrated program down in Southwest Washington.

I think the state and the state's actuaries realized that they mispriced that business somewhat, and we've been working with them to correct that. But the medical management efforts that Dr. Wilson and his team have put in place have really stabilized utilization, brought it down, and we do think that we're making good progress..

Got it. And then just a clarification. You mentioned in the press release some rate pressure being reversed in January 2017. I'm just wondering if that was specific to the fourth quarter, because it's a bit unusual to talk about rate pressure so late in the year for the rate resets. So if you could clarify that a little bit more..

Sarah, it's Joe speaking. What we were just tried to point out there is that, in those three states, where we have seen some margin pressure – Ohio, Illinois and Washington – we did receive some pretty decent rate increases effective January 1, 2017, which we'll go into more detail tomorrow.

But I would just say that in today's state funding environment, you generally don't get 4% to 5% rate increases without there being some pressure on margins..

Thank you..

Our next question comes from the line of Ana Gupte with Leerink. Please go ahead with your question..

Yeah. Okay. Thanks. The first question is around Medicaid expansion. It does look like you had a pretty big sequential MLR increase just on our early read of this as opposed to TANF and CHIP. I'm just trying to understand what's going on there.

And you talked about December being the pressure point, was that flu and more cost-related or something else? And does that a big contributor in the deterioration in loss ratio in some of the states that you had, Ohio, California, Illinois, Q-over-Q?.

Well, Ana, it's Joe speaking. Two points I'd make about Medicaid expansion. First, as we spoke about in the first quarter, just we started this year with rates on Medicaid expansion coming down, which lowered margins. We also – if you recall, we had a Medicaid expansion rate cut in California mid-year.

The additional item that's happened regarding expansion in the fourth quarter is our determination that we were going to have to take a charge of about $40 million, $45 million out-of-period related to an item in New Mexico involving contractual interpretations on our Medicaid expansion contract..

So, that was the only reason is New Mexico, wasn't anything you saw in some of the other states I just talked about that had the issue?.

No. Again, as far as Medicaid expansion, the big dip really took place January 1 of 2016 when new rates rolled in..

Okay.

So, you still maintain that the worst of the rate pressure is behind us and you're not going to see pressure going forward on expansion?.

Yeah. I think we're certainly seeing – we'll talk more about this tomorrow. We've actually seen a little bit of relief in Washington.

I think our point would be our – as you would probably be that over time, as the Fed stops funding expansion so much that those margins are probably going to approach the TANF and ABD margins, which is why we're so pleased with the progress we have made this year in TANF and ABD..

Then, on the exchanges, if I could get a little bit more clarity around, you talk about the risk (34:20) which I'm assuming is risk adjusters and those seem to have come in a lot worse than expected. And then, you talk about risk corridors not delivering and you saw some cost pressures, but you didn't see the relief from risk corridors.

Can you talk about what percentage of the miss with risk adjusters relative to risk corridors? And I understand Moda might have won the case and all, but that's a lot more dicey, right, than risk adjusters?.

So, this is Mario. First of all, on the risk corridor issue, we do believe that we are owed the money, and our case is very similar to the one that was filed by Moda, so we do believe that we'll prevail in that. The biggest single problem we have, and we started saying this earlier in the year, is the risk corridor methodology.

The fact that we are a plan that has relatively low premiums, relative to the state-wide average, really hurts us. And to give you an example, in California where we operate only in Southern California, the costs in Northern California are about 30% higher, so it drags up the statewide average and further magnifies the problems that we have.

The basic problem that we have today and going forward is around risk transfer. I think the secondary problem is the Special Enrollment Period, and perhaps the new regulations will address that. But we need to continue to press for some relief on the risk transfer issue..

The risk transfer corridors or adjusters or both? I'm still not clear..

There are three Rs. So there's reinsurance, risk corridors and risk transfer. Right now, the first two have gone away, and the risk transfer remains. So, it's going to be a problem going forward, unless something is done, and that's what our advocacy efforts are focused on..

And if you don't get....

Ana, I'm sorry. It's Joe. Just to be clear, I think from the terminology you're using, you would relate risk transfer to risk adjustment..

Okay. Okay.

And if you don't get what you have, what you need with advocacy, might you consider exiting for 2018?.

Yes..

Okay. Thank you. I appreciate the color..

Our next question comes from the line of Gary Taylor with JPMorgan. Please go ahead with your question..

Hi. Good afternoon. I just wanted to get a little more color on page 2, and maybe I missed this, and I think Joe White has alluded to one of the items.

But items two and three, so when you talk about items – $25 million related to 2014 and 2015, is that prior to your development or is that specific contractual issues? And it sounds like maybe number three was the New Mexico thing you'd just mentioned, but I wanted to clarify..

That's correct. Both of those items relate to unique issues specific to states, one being the New Mexico item I talked about, the second one being in the state of Illinois, where the state cut back on Medicaid rates and risk adjusted been back to the beginning of 2016.

So it's not prior period development issue we think of it in terms of the claims liability. It's specific contractual revenue issues..

Got it. And the $1.21 per share loss related to Marketplace, that I presume I'm sure that includes the full risk adjustment payment you're talking about.

But the PDR impact is also included in that $1.21?.

Bear with us for a second. I'm trying to find the $1.21 you're talking about..

I thought you said....

(38:33) at the very beginning..

Yeah..

Yes. Yes. That is correct. That $1.21 does include the impact of the $30 million PDR..

Okay. Thank you..

Our next question comes from the line of Tom Carroll with Stifel. Please go ahead with your question..

Hey there. So good evening, I guess, for us, and good afternoon to you guys. But your stock is going to be on sale here tomorrow and probably for a little while.

Has the management team discussed doing anything like maybe pulling in the share repurchase sometime during the first quarter or discuss the policy like that especially with the breakup fee coming from the Humana deal?.

Hi, Tom. This is Mario. We do have an authorization for share repurchase from the board, but we're not planning to do a share repurchase at this time..

So, you don't think that would be something that would maybe support the stock or show some confidence in your planning and everything that you're doing going forward? There's just hasn't been any talk of that at all?.

No..

Okay. Thank you..

There are no further questions at this time. I'll turn the call back to the presenters..

All right. Well, thank you very much for joining us today. And just a reminder that tomorrow we'll be discussing the outlook for 2017; that will be at the Parker Méridien at 12:30 PM. And, please, join us in person. If you can't, it will be webcast. We look forward to talk with you tomorrow..

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines..