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Edited Transcript of AET earnings conference call or presentation 2-May-17 12:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Aetna Inc Earnings Call

HARTFORD May 10, 2017 (Thomson StreetEvents) -- Edited Transcript of Aetna Inc earnings conference call or presentation Tuesday, May 2, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joseph F. Krocheski

Aetna Inc. - VP of IR

* Karen S. Lynch

Aetna Inc. - President

* Mark T. Bertolini

Aetna Inc. - Chairman and CEO

* Shawn M. Guertin

Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP

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Conference Call Participants

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* Albert J. Rice

UBS Investment Bank, Research Division - MD and Equity Research Analyst, Healthcare Facilities

* Christian Douglas Rigg

Deutsche Bank AG, Research Division - Research Analyst

* Christine Mary Arnold

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* Gary Paul Taylor

JP Morgan Chase & Co, Research Division - Analyst

* Joshua Richard Raskin

Barclays PLC, Research Division - MD and Senior Research Analyst

* Justin Lake

Wolfe Research, LLC - MD and Senior Healthcare Services Analyst

* Kevin Mark Fischbeck

BofA Merrill Lynch, Research Division - MD in Equity Research

* Michael Anthony Newshel

Evercore ISI, Research Division - Associate

* Peter Heinz Costa

Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst

* Scott J. Fidel

Credit Suisse AG, Research Division - Director and Senior Analyst

* Thomas A. Carroll

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

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Presentation

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Operator [1]

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Good morning. My name is Rob and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Aetna First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Joe Krocheski, Vice President of Investor Relations. Mr. Krocheski, you may begin.

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Joseph F. Krocheski, Aetna Inc. - VP of IR [2]

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Good morning, and thank you for joining Aetna's First Quarter 2017 Earnings Call and Webcast. This is Joe Krocheski, Vice President of Investor Relations for Aetna. And with me this morning are Aetna's Chairman and Chief Executive Officer, Mark Bertolini; and Chief Financial Officer, Shawn Guertin. Following the prepared remarks, we will answer your questions. Karen Lynch, Aetna's President, will join us for the Q&A session.

As a reminder, during this call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently projected results are described in this morning's press release and the reports we file with the SEC. We have also provided reconciliations of certain non-GAAP measures in our press release and guidance summary. These reconciliations are available on the Investor Information section of aetna.com.

Please note 2 changes to our disclosures this quarter. First, we have changed the naming convention of our non-GAAP measures from operating to adjusted. We did not change the underlying calculations of the consolidated metrics, just the labels. Second, effective March 31, our business segment results are reported on a pretax basis as income taxes are no longer allocated to our business segments.

We would also like to highlight Aetna's investor update meeting, which will be held in New York City on Friday, May 12. While space for in-person attendance is limited, a live webcast will be available.

Finally, as you know, our ability to respond to certain inquiries from investors and analysts in nonpublic forums is limited, so we invite you to ask all questions of a material nature on this call.

With that, I will turn the call over to Mark Bertolini. Mark?

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [3]

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Good morning. Thank you, Joe, and thank you all for joining us today. This morning, Aetna reported first quarter adjusted earnings of $2.71 per share, representing year-over-year growth of 17% and a strong start to the year. Underlying our first quarter performance, we exceeded our previous membership projections, ending the quarter with approximately 22.4 million medical members. We reported adjusted revenue of $15.5 billion, led by strong year-over-year growth in Government premiums, which now represent over half of total health premiums. Medical cost trends remain moderate, and we experienced favorable prior years' reserve development across all of our core products in the quarter. We achieved an adjusted pretax margin above the high end of our target range. We delivered strong performance in our core businesses, allowing us to absorb continued pressure in our Individual Commercial products, which included establishing a $110 million PDR. And we generated approximately $980 million in Health Care and Group Insurance cash flow during the quarter.

Based on our strong start to 2017, today, we have updated our full year 2017 guidance. We established a year-end medical membership projection of approximately 22.2 million members. We now project we will generate approximately $61 billion of adjusted revenue compared to our previous projection of approximately $60 billion to $61 billion. And we increased our adjusted EPS projection to a range of $8.80 to $9 per share, up from our previous projection of at least $8.55.

In a few moments, Shawn will provide a more detailed review of our first quarter results and updated 2017 guidance, but first, I would like to reemphasize Aetna's mission and strategy as well as highlight some of our operational accomplishments in the quarter. A number of years ago, we defined Aetna's mission as building a healthier world. With that clear mission in mind, we set Aetna on a strategic course to position the company to be the health partner of choice for the people we serve. While some aspects of how we achieve the strategic objective have evolved, the primary tenets have remained constant: help transform the health delivery model to one that is focused on value and improved outcomes and deliver a more consumer-oriented experience for our members to enable them to achieve their personal health ambitions.

We made significant progress on these fronts in 2016 and have carried that momentum into 2017. During the quarter, we continued to develop new value-based care collaborations across a wide spectrum of models as we continue to meet providers where they are. We also made additional strides in bringing our 2016 joint ventures online. Our more mature VBC models continue to demonstrate reductions in medical costs relative to the marketplace while improving outcomes across a number of metrics, including decreasing avoidable surgical admissions, increasing generic prescribing and improving the monitoring of patients' medication therapies after a heart attack. We also made new strides in our consumer efforts in the quarter. Specifically, we rolled out our bswift platform in a number of new geographies, we advanced our analytical capabilities and predictive modeling tools and we continued to evolve our care models to help drive health care delivery deeper into local communities and closer to home. The favorable impact of these efforts is evidenced across several objective measures, including industry-leading Medicare star ratings; strong quality scores across a number of measures in Medicaid, including NCQA quality measures; and above industry average growth rate in Individual Medicare Advantage and strong adjusted pretax margins that have consistently been in our target range of high single digits.

We are pleased with our continued progress towards achieving our strategic goals and company mission. I am confident that our recent progress and continued investment will position Aetna to be the health partner of choice for people to achieve their personal health ambitions.

Moving on to operational highlights. Let me begin with our Government business, which continues to be the predominant driver of our growth story. We had another strong quarter in our Medicare business, with membership growth driven by Individual Medicare Advantage products. Our industry-leading star ratings and positive brand recognition continue to resonate with Medicare consumers as evidenced by our nearly 13% sequential individual MA membership growth, which once again exceeded overall Medicare program growth. In total, including Medicare Supplement, we have grown to serve 107,000 additional Medicare members in the first quarter, capping another strong annual election period for the company. While Group Medicare Advantage membership was down modestly in the quarter, we are very confident in our ability to grow in group MA next year based on early 2018 pipeline conversions.

Continuing on with our Government business. Medicaid delivered another quarter of solid revenue growth and underwriting margin performance. Aetna served nearly 2.4 million Medicaid numbers at the quarter-end, an increase of approximately 62,000 from the same time a year ago. As a result of our focus on improved member outcomes, we are confident that Aetna is well positioned to take advantage of the strong growth dynamics in Medicaid as states continue to look to the private sector to manage the health of their Medicaid beneficiaries.

Aetna's strong positioning and the demographics supporting Government revenue growth makes it one of the most compelling opportunities for the foreseeable future. With that as a backdrop, we have incorporated into our updated 2017 projections an increase in targeted investment spending to drive increased government-sponsored growth. A portion of these investments reflect known 2018 group MA wins to date with additional investments to drive increased Medicare membership growth in 2018 and beyond, including the continued expansion of our geographic footprint.

In Medicaid, we see opportunities to continue to drive growth based on a strong RFP pipeline. Moving forward, we will continue to look for additional opportunities to make further investments that will prudently accelerate our growth in Medicare and Medicaid in order to serve more of these growing populations.

Shifting to our group Commercial business. Our Large Group Commercial products performed well in the first quarter, achieving top and bottom line results that exceeded our initial expectations. We maintained stable membership in our U.S. Large Group Commercial products during the quarter. And medical cost trends for insured products remain moderate and largely consistent with expectations. Our Commercial ASC and fee-based businesses also performed well as the 2016 momentum observed in this business carried into 2017. As we look to the remainder of the year, we remain confident we will grow our Large Group Commercial ASC membership.

In summary, we are off to a good start to 2017. Our strong start to the year has enabled us to increase guidance and make investments that we believe will position Aetna to achieve our long-term growth objectives. I want to thank all of our employees for their efforts in delivering another strong quarter for Aetna and our shareholders. With the momentum from the first quarter, I am confident we have the right vision to lead in a changing health care marketplace, that the investments we are making will position Aetna to succeed as a health partner of choice for the people we serve, and we can achieve our updated 2017 adjusted EPS projection of $8.80 to $9 and drive long-term, sustainable growth.

I will now turn the call over to Shawn, who will provide additional insight into our first quarter results and our updated 2017 outlook. Shawn?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [4]

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Thank you, Mark, and good morning, everyone. Earlier today, we reported first quarter 2017 adjusted earnings of $939 million and adjusted earnings per share of $2.71. These results represent year-over-year growth of 14% and 17%, respectively, and continue to be supported by strong cash flow, balance sheet and adjusted margins.

I'll begin with some comments on overall performance. Our medical membership of 22.4 million is approximately 100,000 higher than the top end of our previously projected range for March 31, driven by better-than-anticipated Commercial ASC growth and lower-than-projected Medicaid membership declines. Adjusted revenue was $15.5 billion, a modest year-over-year decrease, driven by lower membership in our ACA-compliant Individual and Small Group products and the 2017 suspension of the health insurer fee. These dynamics were partially offset by higher Commercial premium yields and membership growth in our Government business. From an adjusted pretax margin perspective, our businesses are performing quite well. Our adjusted pretax margin was 10%, a strong result and above the high end of our target adjusted margin range.

Our first quarter total health medical benefit ratio was 82.6%, a strong result that benefited from continued moderate medical cost trends and favorable prior years' reserve development. We achieved this result despite the impact of a $110 million premium deficiency reserve associated with our Individual Commercial products.

Our adjusted expense ratio was 16%, a 200 basis point improvement over the first quarter of 2016, driven primarily by the suspension of the health insurer fee in 2017 and execution of our expense management initiatives. Relative to our previous projections, this metric benefited in the quarter from the timing of previously planned spending, which we now expect to occur during the remainder of the year.

From a balance sheet perspective, we remain confident in the adequacy of our reserves. We experienced favorable prior years' reserve development in the quarter across all of our core products, primarily attributable to fourth quarter 2016 dates of service. And our days claims payable were 53 days at the end of the quarter, a sequential decrease of approximately 1 day.

Turning to cash flow and capital. Health Care and Group Insurance cash flows were approximately $980 million in the quarter. During the quarter, we initiated a $3.3 billion accelerated share repurchase program, which retired 20.9 million shares. We returned approximately $88 million to shareholders through our quarterly shareholder dividend. We also announced the doubling of our quarterly shareholder dividend, which took effect last month. In short, we are pleased with our first quarter results and the continued successful execution of our strategy to become a more consumer-focused company.

I will now discuss of the key drivers of our first quarter results in greater detail. Beginning with our Government business, we delivered another solid quarter continuing our momentum from 2016. We grew our first quarter 2017 Government premiums by over 9% compared to the prior year period, achieving a quarterly record of $7.1 billion. This quarter marks the first time our Government premiums have exceeded our Commercial premiums. From a membership perspective, we grew by 107,000 Medicare members, led by growth of 99,000 in Individual Medicare Advantage. Medicaid membership declined by 90,000 members in the quarter related to our exit of the Nebraska Medicaid contract at the beginning of the year. This was a better result than previously projected due to the delay in changes related to our Pennsylvania Medicaid contract.

Our Government medical benefit ratio was 85.3%, a continuation of the strong results we achieved in this business in 2016 and a very good start to the year.

Shifting to our Commercial business. The strong momentum of 2016 continued in the first quarter with our Commercial ASC membership increase of approximately 219,000 members as Large Group Commercial membership gains outpaced our previous projection. Increased sales drove this improvement, a confirmation that our value proposition is resonating in the marketplace, particularly with public and labor customers.

In our Commercial Insured business, membership decreased in the quarter, largely the result of declining ACA-compliant Individual and Small Group membership. As a result of actions taken to reduce our footprint in 2017, our Individual business now represents less than 2% of total adjusted revenue. Our Commercial medical benefit ratio was 79.4% for the quarter, a very good result despite continued pressure from our Individual Commercial products. Our group Commercial products performed very well in the quarter, benefiting from moderate medical cost trends and favorable prior years' reserve development. Based on first quarter results, we continue to project that our 2017 non-ACA core Commercial medical cost trend will be in the range of 6% to 7%.

With respect to our Individual Commercial products, we continue to face headwinds related to profitability. From a membership perspective, we ended the quarter with 255,000 Individual Commercial members, down from 964,000 at year-end 2016. This result is 15,000 members higher than our previous projection. Based on our current view of membership in these products, we believe the risk pool that we have retained from last year and attracted during this year's annual enrollment has higher cost levels than we had previously projected. As a result of our higher membership and an updated view of the health status of our current membership, we recognized a $110 million PDR, reflecting our expectation for greater losses than previously anticipated for the 2017 policy year. It is important to note that despite this headwind, we continue to project that 2017 losses on Individual Commercial products will be significantly less than those reported in 2016. We expect that the first quarter will mark the high point for our Individual Commercial membership as we project attrition throughout the remainder of 2017. This is consistent with our experience in recent years.

Looking beyond 2017, we continue to evaluate our footprint with a view towards significantly reducing our exposure to Individual Commercial products in 2018. We have already disclosed our planned 2018 exit from one of our 2017 state-based exchanges and intend to communicate other 2018 footprint decisions when appropriate.

Moving on to the balance sheet. Our financial position, capital structure and liquidity all continue to be very strong. At March 31, we had a debt-to-total capitalization ratio of approximately 39.8%.

Looking at cash and investments at the parent. We started the quarter with approximately $15.1 billion. Net subsidiary dividends to the parent were $785 million. We repaid $11.3 billion in debt in the quarter, including $10.2 billion related to the Humana deal financing. We paid $1.2 billion in deal-related termination fees. We paid a shareholder dividend of $88 million. We used $3.3 billion in the quarter for our accelerated share repurchase program. And after other sources and uses, we ended the quarter with approximately $100 million of cash at the parent. Our basic share count was approximately 332 million at March 31.

As a result of our first quarter performance, we are increasing our 2017 adjusted earnings per share guidance to a range of $8.80 to $9 per share. The midpoint of this range represents a $0.35 increase relative to our previous projection of at least $8.55 per share, a meaningful increase especially when viewed in light of an approximate $0.20 headwind from our Individual Commercial products. Our increased adjusted EPS outlook reflects our favorable first quarter results, including the effect of favorable prior years' reserve development as well as the impact of our accelerated share repurchase program. Partially offsetting these benefits are the updated outlook for our Individual Commercial products and the increased targeted investment spending to drive future growth, primarily related to government-sponsored programs. However, certain risks remain that temper our outlook at this point in the calendar, including the ever-present concern that medical cost trends could increase more than we have projected, low visibility at this juncture of the year into our ability to achieve our updated outlook for Individual Commercial products and the potential for the health insurer fee to be permanently repealed during 2017. Our updated 2017 guidance is influenced by the following additional drivers: based on our first quarter membership results, we project that our year-end medical membership will be approximately 22.2 million members as declines in Medicaid and Small Group Commercial during the balance of the year are partially offset by growth in Commercial ASC and Medicare membership over the remainder of the year. As we consider the stronger-than-projected start to the year and our current membership view, we are increasing our adjusted revenue projection for the year and now project that we will deliver approximately $61 billion in 2017 adjusted revenue. Based on our strong first quarter results, we now project that our full year total health care medical benefit ratio will be in the range of 84%, plus or minus 50 basis points. We now project that our adjusted expense ratio will be approximately 16.9% for the full year, up approximately 15 basis points compared to the top end of our previous guidance range. This increase is driven by the increase in targeted growth initiative investments now contemplated in 2017. We continue to project adjusted pretax margin to be approximately 8%, consistent with our high single-digit target. We now project adjusted earnings will be approximately $3 billion. And we continue to project full year excess cash available at the parent to be approximately $4 billion. Finally, as we consider the impact of the previously announced accelerated share repurchase program and our expected capital deployment for the remainder of the year, we now project our 2017 weighted average share count to be in the range of 334 million to 335 million shares.

In closing, we are encouraged by the strength of our first quarter results and our improved 2017 outlook, particularly at this early stage in the year. Additionally, we remain confident in Aetna's long-term growth prospects and look forward to sharing more details at our upcoming investor update meeting in May.

I will now turn the call back over to Joe. Joe?

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Joseph F. Krocheski, Aetna Inc. - VP of IR [5]

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Thank you, Shawn. The Aetna management team is now ready for your questions. (Operator Instructions) Operator, the first question, please?

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Questions and Answers

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Operator [1]

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The first question is coming from the line of Kevin Fischbeck with Bank of America Merrill Lynch.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [2]

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Yes, question relates to the increase in investment spending that you're talking about for this year. I guess what was it that kind of changed your view about the opportunity for growth? And is the amount that we should think about purely just the amount of increase in the G&A percentage?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [3]

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Yes, so a couple of things on that, Kevin. One, I would say is, we have some insights into the group MA pipeline, and we have some known sales already that we think are going to be significant enough that we have to ramp up for in advance. As we talked about, we thought about what are the kinds of things that we need to do to continue to enhance and accelerate our growth in Medicare. And so we always have sort of a concept of investment money gated that when we look at our performance we make a decision about how to deploy that money. And in this case, we decided to accelerate some spending in the areas of stars, for example, geographic expansion, advancing some things in Medicaid. Again, and so these are all designed to be investments that are either related to known growth or to drive future growth in '18 and thereafter.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [4]

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Okay. And I guess as far as the stars investments that you're making, I guess you have a couple of large competitors who've fallen off on stars recently. And as they look to regain their position that they had maybe 2 years ago and some of these metrics are, in fact, relative, so how do you think about your ability to kind of contain -- or continue these elevated levels of star performance if the peers are trying to catch up as well?

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [5]

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Well, I think of part of falling back is not investing, and so I think we need to keep investing, number one. Number two, Kevin, I think more importantly, we're expanding new markets. So part of what we had hoped to get through the Humana acquisition was access to more geographies. That didn't happen. So we will accelerate our approach to that, and we'll need to get our star ratings up in each of those markets. We know how to do that, and we intend on making those investments to continue growth in those -- in a broader geography. So more new store growth instead of same-store growth.

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Operator [6]

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Our next question is from the line of Josh Raskin with Barclays.

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Joshua Richard Raskin, Barclays PLC, Research Division - MD and Senior Research Analyst [7]

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Just first question. Can you remind us the strategic benefits of running the Group Insurance segment with your Health Care business?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [8]

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Well the -- I think certainly, the disability business is one that has had some linkage historically as we thought about the 2. There are some somewhat arcane benefits in terms of how we position the investment portfolio and things like that. But operationally, they do largely run as 2 freestanding units for the most part. Today there is cross-sell especially on the large accounts, we have a number of accounts where we would have the medical and also the Group Insurance.

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Karen S. Lynch, Aetna Inc. - President [9]

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It's an opportunity for integration. A lot of times, a lot of companies will look at medical and disability, and we can link the disability business with the medical. And we have proof points to demonstrate that when we are selling in the large National Accounts space.

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Joshua Richard Raskin, Barclays PLC, Research Division - MD and Senior Research Analyst [10]

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Has that benefit, that strategic benefit changed over time? Is it the same today as it was a few years ago?

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Karen S. Lynch, Aetna Inc. - President [11]

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Yes, it hasn't changed dramatically over time. Same benefit.

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Joshua Richard Raskin, Barclays PLC, Research Division - MD and Senior Research Analyst [12]

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Okay. And then just real quick, just a follow-up on the $0.19 PDR. I'm just trying to size the Individual losses this year. Other than the $0.19, it sounded like there's more losses on Individual Exchanges also contemplated in 2017. Is there like a full year total P&L impact of the Individual ACA plans that you guys could give us?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [13]

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Yes. So what I would say is that we're tracking towards having about roughly half the loss that we reported last year this year, and that's on 1/4 of the membership that we had, but that's a good sort of proxy. And just to be clear for everybody else, that PDR sort of goes all in and out within the 2017 year. That's all related to the 2017 policy year.

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Operator [14]

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Our next question is from the line of A.J. Rice with UBS.

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Albert J. Rice, UBS Investment Bank, Research Division - MD and Equity Research Analyst, Healthcare Facilities [15]

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I wondered maybe just a follow-up on some of the comments around MA. Obviously, next year, you've got the benefit of star ratings improvement, while others are probably under pressure again. But there is now an increase in the likelihood that if HIF comes back, and as you have to think about that or the market overall has to think about that, it probably has some potential to disrupt benefits. It sounds like you guys think you can grow similarly, especially with the geographic expansions, to what you're seeing this year. I just wanted to maybe flesh out any other views you have about what's happening in MA generally, the underlying growth there, especially as we look into next year and your confidence in that. And then since I'm asking about 2018, I'm going to slip in any update on your thinking about long-term outlook of the $10 for 2018?

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [16]

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A.J., I would comment on the Medicare Advantage. While we're not going to give guidance for next year, we view both same-store growth as continuing to be strong, but also opening up new stores where we saw a fairly sizable portion of our new enrollment this year come from new markets that we opened up. So as we think about the growth profile of the business, it's adding more geographies, it's continuing to invest in star ratings particularly around service and CAHPS in each local market. And I think everybody has to consider that the fees are coming back and that they have to be priced into their product. But it's a market-by-market determination. Some markets were up against the minimum MBR. Other markets, we are not. So we'll look at it market-by-market and price based on what we think the competition is going to do. As it relates to the $10, I'll turn it over to Shawn, and he can tell you a little bit more about that.

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [17]

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Yes. As Mark mentioned, we'll provide 2018 guidance later this year, as is our convention. The point of your question, A.J., obviously is understanding bid positioning. It's a pretty big element to try to understand the year, so we'll do that at the appropriate time. What I would say though is that we're pleased with the 2017 earnings trajectory that we're on at this stage, especially in light of the continued drag that we've had with the Individual business. And as was discussed on the call on a few other questions, we're continuing to invest, and some of that investment is pointed at growth for 2018 and some of that is longer-term growth.

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Operator [18]

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Our next question is from the line of Justin Lake with Wolfe Research.

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Justin Lake, Wolfe Research, LLC - MD and Senior Healthcare Services Analyst [19]

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So questions focused on growth. I want to touch on Medicare Advantage and Commercial risk. So first on MA. There's been some chatter in the marketplace that you picked up a very large group win out there for 2018. And it certainly sounds like you're pretty bullish on the pipeline. Could you give us some color on that large win if it did indeed occur? And how do you see the outlook for group MA first for 2018?

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Karen S. Lynch, Aetna Inc. - President [20]

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So on the large case, I'm not going to comment. It hasn't been publicly acknowledged yet. Relative to Group Medicare, I would tell you that we have a very strong and robust pipeline for '18 that we're quite excited about, and we do expect to have some solid growth coming into January of '18.

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Justin Lake, Wolfe Research, LLC - MD and Senior Healthcare Services Analyst [21]

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Got it. Would you expect your Individual MA performance to be ballpark similar this year in terms of new markets and the contribution from new markets?

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [22]

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We're not giving guidance yet for '18, but we continue to believe that we can exceed industry growth.

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Justin Lake, Wolfe Research, LLC - MD and Senior Healthcare Services Analyst [23]

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And then just on the Commercial risk side, you've outlined Individual. Can you give us some color on what you're seeing in Small Group and where you think that the losses there could kind of stabilize? And what you're seeing in the large group risk market for 2017 would be helpful as well.

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Karen S. Lynch, Aetna Inc. - President [24]

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So relative to Small Group, I just want to remind you all the 3 pieces of Small Group, the 2 to 50 "keep what you have". That has been a pretty stable segment for us, and it is performing within our expectations. The 2 to 50 ACA-compliant book has been probably the most challenging and the most volatile, and that's where you have seen us reduce our overall exposure in that segment. And as I've talked about before, we've offered self-funded bswift capabilities to that segment, which has a very strong market receptivity. And then our 51 to 100, the majority of that book remains medically underwritten and is performing in line with expectation. Relative to the overall Commercial book fully insured, pricing's stable in the market. We're seeing fair amount of activity for the 7/1 selling season, and we continue to remain focused on National Accounts for '18 as well.

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [25]

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Justin, the thing I'd say macro on Small Group is that towards the end of last year, it felt like this started to turn a little bit for us in the favorable direction after having had some challenges. And for the most part, I would say that continued in the first quarter. I continue to be encouraged by the direction that the Small Group business is headed. So that all looks good. And as Karen mentioned, Large Group continues to be a stable performer. We continue to position ourselves carefully on the large group risk side of the business. But again, those segments were generally at or better than expected in the first quarter.

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Operator [26]

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Our next question comes from the line of Scott Fidel with Credit Suisse.

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Scott J. Fidel, Credit Suisse AG, Research Division - Director and Senior Analyst [27]

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Just wanted to follow up again on group MA for 2018, obviously sounds like a big opportunity for you. Can you maybe drill in a little bit in terms of as you look at your pipeline and as you're trying to mine that, sort of how that would break down in terms of the opportunity of converting existing Commercial ASO retiree accounts as compared to new prospects that you're looking to outside of your current customer base?

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Karen S. Lynch, Aetna Inc. - President [28]

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I would say if we're seeing a fair amount of outside prospects, and we are continuing to mine our customer base, but we are seeing a pretty robust pipeline of external customers coming to market.

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Scott J. Fidel, Credit Suisse AG, Research Division - Director and Senior Analyst [29]

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Okay. And then just a related follow-up. Just, Karen, you had mentioned the 2018 National Accounts for Commercial. Maybe just give us a sense in terms of where you stand right now in terms of the size of the pipeline on just the core Commercial ASO side, in terms of the cases out to bid relative to 2017, average case sizes, maybe some metrics like that?

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Karen S. Lynch, Aetna Inc. - President [30]

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Yes, so the relative pipeline on National Accounts is a lower number of cases from last year at this time. Obviously, the book is still maturing. I would say the average number of eligibles is down as well. So as you might imagine, we're not expecting outside growth for 2018. We are keenly focused on retention. I might note that we had the best retention that we've had in a number of years for the 1/1 selling season this year, and we expect to maintain that momentum going into 2018.

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Operator [31]

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Our next question comes from the line of Michael Newshel with Evercore.

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Michael Anthony Newshel, Evercore ISI, Research Division - Associate [32]

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Mark, could you share your latest thoughts about the CVS relationship and how you like to see that evolve and how might it be affected, if it all, by any shuffling of PBM alignments among your peers?

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [33]

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Well, I would say that as we get closer to our 1/1/20 renewal date, it's the first opportunity to consider renewing it. We continue to look at what we can do in contract, and so we have some developments and conversations under way around our Medicare product as well as our Commercial product. But I think going forward, the PBM relationship as a stand-alone model is a troubled relationship as we look at all the noise around drug pricing and where are the discounts or where are not the discounts. It is still our view that drug pricing transparency is incredibly important for all consumers. Secondly, that it's all-in cost for us by therapy because that fits within a risk-based model where there's a premium against which all costs are measured. So the lowest cost of therapy, maybe higher drug cost, lower other cost, maybe higher other cost, lower drug costs, are very important. And so as we talk to CVS about our relationship going forward, we're trying to fundamentally rethink how we could work closer together both on just the pharmacy side but also on the local care delivery that could go on in the community given that CVS has 9,000 stores within 3 miles of 80% of the American public. It has been our view that we need to get closer to home and closer to the community to help people with social determinants and other costs that are based near their home versus waiting for them to show up maybe once a year at the doctor to get information about how they're doing.

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Michael Anthony Newshel, Evercore ISI, Research Division - Associate [34]

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And do you see building out those more retail provider capabilities in terms of CVS acquiring those capabilities? Are you guys doing it together through some sort of JV or partnership? Or are sort of all things on the table now?

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [35]

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Still too early to tell. We're in the midst of those conversations with multiple players.

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Operator [36]

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Our next question is from the line of Chris Rigg with Deutsche Bank.

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Christian Douglas Rigg, Deutsche Bank AG, Research Division - Research Analyst [37]

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I was hoping you could give us a little more color on the components of the medical cost trend. Obviously, the total number is tracking in line, but just would love to get a better sense for how inpatient, outpatient, pharmacy are tracking at this point in terms of year-to-year changes.

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [38]

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Chris, I mean, unfortunately, this is a bit of a boring story in that not a lot has changed sort of on the pressure points or the new ones. I would say overall, again, we had a very well-behaved, moderate cost trend quarter. Certainly looking at prior-period development, that didn't lead to any surprises as those periods have matured. So we're probably looking -- continue to look at inpatient in the mid-singles, physician in the mid-singles, outpatients in the high singles and pharmacy in the low double digits. And the pharmacy story really continues to be one that's all about specialty pharma. I think that comprises something on the order of 40% now of the costs and a very low percentage of the scripts. And so when you really dig into it, as I've said before, it continues to be issue 1, 2 and 3 when you look at the medical cost trend drivers.

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Operator [39]

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Our next question is from the line of Gary Taylor of JPMorgan.

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Gary Paul Taylor, JP Morgan Chase & Co, Research Division - Analyst [40]

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I just want to clarify an understanding of something first just going to the Individual market. I think for 2016, you have suggested $450 million of pretax loss, and so it sounds like that's going to maybe $225 million this year. I think you said last year, you would've been break-even or slightly profitable at the risk adjustment accruals which look like they would have been 10%, a little north of 10% of gross premiums. So first question is, have you made a change to the risk adjustment accrual percentage for 2017? How does that compare year-over-year in terms of how you're thinking profitability plays out this year?

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [41]

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Before I have Shawn answer that specific question, let me remind you that last year when we made our decision in July to withdraw from exchanges, we had a view that we could be running near $800 million to $900 million loss in 2017. And based on our first quarter results and our projection for the year, it appears we are running at that number. And so our attempts to stem the impact of this product set on our overall earnings and capital structure was appropriate and very important at that time, but yet we're still above what we thought we would project. Shawn?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [42]

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Yes. So Gary, this is one of the areas -- when we talk about the areas of uncertainty that we have understanding again the risk adjustment of this very different and changed population from what we had last year is one of those challenges, especially in the first quarter where we really don't have mature data. The short version of the story is, we still are in a fairly -- we estimate that we're going to be in a pay-in position that will probably in a relative sense be a little bit less of a pay-in position than we were last year just given what we've seen happen to our book. But again, there's still a lot of uncertainty and blind spots that we have in terms of we know what happened to some degree to our population, but we don't know what has happened in the overall market. So the takeaway is that we still have a risk-adjuster pay-in position, but a little bit -- maybe a little bit improved off of last year based on what we've seen so far.

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Gary Paul Taylor, JP Morgan Chase & Co, Research Division - Analyst [43]

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Okay. And if I could do one other question. On PDR -- or not PDR, prior year development coming into the year, I think there was $0.46 of net prior year development recognized in '16. You hadn't guided for that for '17. So at this point, is there still some conservatism related to PYD? Is the net effect you expect to realize mostly in the year because of 1Q? And is that net realized amount down from 2016?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [44]

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Yes, so I'll just clarify. I don't think we guided for any PYD in our initial guidance. We've certainly have talked about what the historical levels have been. So we had in the first quarter probably on the order of $0.30 to $0.35 of PYD. Again, if you look at past years, we've continued to get smaller amounts of PYD in the subsequent quarters going forward. So I certainly don't -- that certainly wouldn't be a surprise if that happened and we got some more in the second quarter of the year, for example, as that's how most of the prior years have played out.

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Operator [45]

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Our next question comes from the line of Tom Carroll of Stifel.

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Thomas A. Carroll, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [46]

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So in the past, you have discussed the potential to perhaps build out an Aetna services segment, if you will, that would house the various clinical IT and other non-benefit-related businesses that Aetna currently operates. I guess, where does that fit into your current growth strategy now that Humana, we're done with that? And maybe you'll talk more about this at your Investor Day, but if you could just chat about that a little bit.

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [47]

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We will talk about it more at our Investor Day, Tom, but we are building that out. We are -- it is one of the foci of our investment portfolio for 2017 that we put into the plan. And as we looked at what we found very valuable in the Humana transaction, it was more geographies through which we can provide more Medicare Advantage products. And secondly, the whole model that Humana has built about being in the home and the community and a clinical model that approaches and supports that. And so that is what that services division will do. It's currently under way. Gary Loveman is building that out, and we'll have more to say about it in December.

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Thomas A. Carroll, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [48]

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Can you provide some timing perhaps on that? Or would there be a branding campaign that goes along with it?

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Mark T. Bertolini, Aetna Inc. - Chairman and CEO [49]

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More to come on that. We'll talk a little bit more about that in May on May 12, but we'll have more detail when we get to December.

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Operator [50]

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Our next question is from the line of Christine Arnold, Cowen and Company.

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Christine Mary Arnold, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [51]

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Two things. Number one, you had referenced a group MA known win. Can you give us a sense for the membership in terms of what you've already gained? And with respect to Medicaid, can you talk about the pipeline? I know Pennsylvania is probably a bad guy, but what are you seeing in terms of potential good guys on the Medicaid enrollment?

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Karen S. Lynch, Aetna Inc. - President [52]

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So Christine, I'll start with Medicaid. We have 4 implementations currently in process, so you'll see those coming through the remainder of the year. We're monitoring probably over a dozen RFPs that will come out within the next 12 to 18 months or so. So we feel there's a pretty solid pipeline relative to Medicaid. And relative to group MA question, I can't give you that number at this point.

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Operator [53]

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We have time for one additional question this morning from the line of Peter Costa with Wells Fargo.

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Peter Heinz Costa, Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst [54]

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I just wanted to quantify a couple of numbers, if I could. If the health insurance fee is repealed, it would create a headwind for you for this year, correct, in terms of midyear renewals? How much is that? And then can you quantify how much the alternative funding arrangements are producing in revenues right now for small groups and what's it growing by?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [55]

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On the headwind piece, that originally was going to be about a $0.10 benefit. And as you all recall, it's just really an anomaly of sort how the accounting works for that recovery. Obviously, as the year goes on, some of that's built into pricing already. It could decline slightly, but I think it's best to think about that as about a $0.10 item on that. We are probably over, Karen, about 100,000 AFA alternate funding Small Group members. I don't have the revenue in front of me, but we can certainly follow up.

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Peter Heinz Costa, Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst [56]

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Okay, and what's that like growing by year-over-year?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [57]

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Well, it's huge because we just launched it last year, right? So there's no denominator there. So it's grown pretty. A lot of that growth happened in the back of last year and in the first quarter of this year especially.

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Peter Heinz Costa, Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst [58]

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Okay. And then just to be clear, the $0.10 benefit of that is impact is in your estimate today or in your guidance today?

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Shawn M. Guertin, Aetna Inc. - CFO, Chief Enterprise Risk Officer and EVP [59]

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Correct.

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Joseph F. Krocheski, Aetna Inc. - VP of IR [60]

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Thank you, Pete. A transcript of the prepared portion of this call will be posted shortly on the Investor Information section of aetna.com where you can also find a copy of our updated guidance summary containing details of our guidance metrics, including those that were unchanged or not discussed on this call. If you have any questions about matters discussed this morning, please feel free to call me or one of my colleagues in the Investor Relations office. Thank you for joining us this morning.