CVS Health Corporation (NYSE:CVS) Wolfe 2024 Healthcare Results Conference November 19, 2024 10:20 AM ET

Company Participants

Tom Cowhey - Executive Vice President, Chief Financial Officer

Conference Call Participants

Justin Lake - Wolfe Research

Justin Lake

Got to mention Larry McGrath, the head of strategy in IR refused to sit up here with us, but he's doing God's work for the company, and we all appreciate it. Thank you, Larry. So, Tom, before we delve into the numbers, a lot going on. You've had some management change. David steps in as the CEO. Prem steps up to president. You've got four new board members that were announced yesterday. Maybe you could just give us kind of a lay of the land on how you see this changing the trajectory or kind of the strategy of CVS to the extent it is.

Tom Cowhey

Absolutely. So, first and foremost, so I don't get the hook from my legal team, we will make forward-looking statements today. So please consult our risk factors as filed in our documents with the SEC. Thank you. The listen. Let me start with, with David. I've known David since about 2008. I was actually in the corporate development group at Aetna. We were evaluating alternatives for our PBM and he ran the health plan business at Caremark, and helped, work us through that very successful outsourcing of our PBM, to Caremark at the time.

He he's a great individual with a tremendous amount of industry knowledge and experience. And so, we're excited to have him at the helm. I think he's, I think he's going to bring a lot of great things to the organization. Prem is somebody that I've also got to know, really well since I came back. I don't think anyone, realizes from the outside, Prem has run our pharmacy business, the retail business as you think about it. He's also our chief pharmacy officer.

So, as you think about what does that mean, that means that things like our specialty operations are actually managed by Prem. And so, you think about underwriting and pricing and the sales for the specialty business that rolls up in P&L responsibility inside the health services segment inside Caremark, but Prem was actually managing those operations. So, a lot of this is very natural. Prem's been, in the PBM business for most of his career. He's been with, the CVS for about a decade now.

And so, I think there there's a there's something very natural about the two of them, coming into this role and, combined, they were the driving force between cost vantage and true cost, which I think is really poised us to try to change the industry and change our pricing works in that industry.

With respect to, the new board members, we're excited to work with them. I think, Glenview has been a fabulous shareholder. They've been very supportive. They're supportive of the strategy. I think, they, they have some views about how we can do things better, and we're all ears. So, we're really excited to continue to work constructively with them, and I think that, this is going to be a good relationship.

Question-and-Answer Session

Q - Justin Lake

Appreciate that. Maybe, to, think about the, the current kind of baseline of what's going on both in the industry and at the company. Obviously, you saw some higher costs into kind of running out of 2Q into 3Q. And, while you didn't give guidance, you gave a framework of how to think about, costs into the Q4. And, you talked about an MLR, I think, of 95.5%, and, you talked about the fact that that would embed higher trends, kind of peak trends coming out of 2Q that you had seen versus maybe what looked like some moderation in 3Q.

So, what I was hoping to get from you here is you've closed October. Obviously, the key at least the key early data point is how 3Q is running out. You got another month of insight into that. Hoping you could share with us kind of what you're seeing there. Is it looking more like a return to that 2Q peak, or is it looking, continuing running along what you thought 3Q was, such that maybe things are a little better?

Tom Cowhey

October is obviously still pretty immature. What we had said when we were on the call even, we said, we had some early views onto what October looked like, which was part of what drove us towards this scenario. I'd say, as we closed out the month, isn't materially different than what I knew when we were partially closed on the month, when we talked at the earnings call. We had seen net positive development of the 9/30 reserves. A lot of that was stemming from earlier dates of service with some pressure on some of the more recent dates of service.

And so, that was what led us to present the scenario to investors. Some have called it a reasonable downside scenario. I think that's a good way to look at it. But, as you think about what we've experienced throughout this entire year, it has been, even as you look at the second quarter, second quarter was -- we saw negative development of the second quarter. The second quarter trends were some of the highest that we've seen all year, particularly in our Medicare business.

And so, I think we have a prudently cautious posture, as it relates to how 2024 plays out that we've tried to outline for investors, but recognizing that, it's some of this variability that has caused us not to specifically guide for the remainder of the year or for '25.

Justin Lake

Right. And I get that October is going to be immature at this point, but I was more thinking about, how did you're getting more information on July, in August, and September, right? That's going to tell you how 3Q really looked versus 2Q. How is that how is that coming out?

Tom Cowhey

The formal October close is no different -- is not materially different than what I shared with you at the time of the earnings call, right?

Justin Lake

So, still feels like the 3Q looks better than 2Q, but to our recall, that's the way to think about it.

Tom Cowhey

That's accurate.

Justin Lake

Got it. And so, as you think about setting up 2025, I'm not lucky enough to get guidance, today, but maybe you could think about a framework that we should think about in terms of -- you basically in my mind, you gave almost all of the moving parts with the key swing factor being Aetna. The business is breakeven this year. You're effectively saying, we believe strongly it's going to improve next year. It's a question of how much improvement.

So maybe you can give us -- and honestly, if I think about people thinking between, let's say, $5.75 and $6.25 $5.56, it comes down to $1 billion at Aetna, give or take, and $0.5 billion to $1 billion at Aetna, and that's almost 0.5% to 1% margin, right? How do you think about what are the key swing factors that are going to decide whether you -- where that shakes out?

Tom Cowhey

Sure. So, the easiest place to start is with the businesses that aren't losing money or that are losing money. And so, we -- and I talked about this on the earnings call. So, couple of points of potential loss on a $20 billion Medicaid business, right? That's really about the dislocation between acuity and trends. Redeterminations have happened, healthier individuals have come out of the pool, the rates haven't caught up. That will start to get better early parts of next year, a little less than half the book on renews on 1/1, so it has different rates. I don't think you'll hit closer -- you won't get to the right run rate until we're really at the end of '25 into '26. So that's a -- that's probably the smallest hole right now, but we will improve. I don't think that it's going to get -- it's not going to get back to target margins in '25, right?

Individual. So individual exchange. Individual exchange is about a $10 billion net revenue book right now. And in the scenario, I outlined, which incorporated a little bit of additional potential pressure on risk adjustment, you could see a case where that business loses just use round numbers up to $1 billion this year, right?

So, assuming that we're not carrying additional risk on risk adjustment into 2025, which we did this year, you have about a $225 million out of period from '23 in those numbers, that should hopefully get better. So, then the question becomes, with this book that we've said could shrink 20%, 25%, I wouldn't be upset if it shrank a little bit more than that, we're losing $750 million to $800 million. We've put double-digit rate increases in shrinking the book should help.

Do I think it's going to get back to zero margin next year? No, but I think it will be a -- we will make earnings progression in that business. And a lot of this is very geographically focused. So, we have a lot of teams that are working on the ground to look at our networks and what can we do with providers and are there things that we can renegotiate. But that also makes it much easier from a decision-making standpoint if we're not seeing the progress in membership mix or in profitability or journey towards that profitable target in '25, we have the option to remove products or pull out of markets for '26, which should help that business over the course of the next 2 years.

So then really, it comes down to Medicare. So, Medicare is a business that, if you say mid-single digits, could lose $3.5 billion this year. What's going to get better next year? So, we have Stars. Stars is $800 million, plus or minus, next year. That will definitely improve the picture. We've got about 0.5 million members that are looking for new homes this year.

So, they were in an existing Aetna product in 2024, and we've pulled those products from the market. About a little less than 10% of that are in geographies where there's not a new Aetna product that was offered to them. In the other geographies, they do have a choice to take a new Aetna product that's been redesigned. It's not a target margin product, just given the dynamics of this marketplace and crafting an attractive product, but it's substantially better than the existing profile of these members. And for that 0.5 million members, they are at MBRs that are materially worse than the average of the book.

And so that's another margin improvement opportunity as we think about next year. And then the last piece is effectively what we've done with supplemental benefits. And so, what we've done with supplemental benefits is we've put in some hard caps. And so, things that have been pressure points this year, it's not mathematically possible for them to be the same amount of pressure in 2025.

And so that should improve results. The wildcard is trend. So where is that trend at the end of the year? What does that mean for the jump-off? And with the changing membership mix, how does that impact how we think about trend for 2025 and therefore, how we guide? And that's something that we'll have a much better viewpoint on as we think about -- as we get into February because we'll have a much better sense as to how open enrollment has actually come to pass.

Justin Lake

Got it. And if I just kind of wrap this up, the way I've been thinking about it is simply, if you go back to 2Q, company said we're seeing costs at x. And we are -- we have embedded trend -- a trend assumption that continues to be pressured, right? So, Humana, United, typical trend in Medicare Advantage, call it, 4% to 5%. Everybody is saying they are bidding to normal next year, right? They're bidding for whatever the level is in '24 to go up 4% to 5% next year. You were saying, no, given what we're seeing and focus on margin over membership, we're going to be higher than that. We're going to be high single digits, let's call it 6%, 7%, right?

So, couple of hundred basis points above where everybody else is pricing. And you could see it in the benefit designs, right, that we've all kind of looked at, right? The -- so now I think the question becomes, let's say, you're at $1 of cost in 2024, right, as of the second quarter, if costs end up being $1.02, right, they just end up being higher as you run out the year, your run rate is $1.2, do you still feel like you need to put that 6% to 7% trend so effectively grow off the even higher base at a higher level? Or do you assume, okay, this feels like peak, we can grow at 4% to 5%.

And the way I've kind of framed it for investors and my note yesterday that I put out, I guess, yes, yesterday, was you guide to $6, if you assume even -- if the worst case happens, the conservative case plays out this year, you assume trend then is more normal off that higher level and you guide to 5.50, if you just say, what, we're going to be super conservative. No matter how high it got in 2024, we're going to assume 6% to 7%, right? And we're going to start there. Is that a reasonable way to think about that framework when you put it all together?

Tom Cowhey

There's -- we obviously haven't guided for '25, so I want to be careful not to do that here. But I think you're thinking about the -- conceptually you're thinking about this in the right way, which is part of the reason that we haven't guided on '25 yet is we want to see where '24 is. We also want to see that membership mix. And those two things are important for the following reasons. The first is part of this is a function of -- part of why we are different and not all of it, but part of why we're different this year is the level of supplemental benefit usage that we've had. We've talked about this at some of the things that we did in products that were very popular, including with our OTC, our Flex cards, our dental benefits, things that have been fundamentally restructured.

And so, part of the pressure that we've seen this year has come in those benefits that have been fundamentally rewritten. And so, if we see incremental pressure in the fourth quarter on a benefit, that benefit to use your example, goes from $1 to $1.10, right? Then -- but it's said, it's capped for next year at $0.50. Then like that, $0.10 of incremental pressure is not going to repeat. And so...

Justin Lake

It's irrelevant how do you think about that?

Tom Cowhey

Right, because it's a newly designed capped benefit. And so that's part of what we're trying to understand as we look and what we will be trying to understand as we look at where the fourth quarter plays out as we think about that baseline, exactly where the trend happened is going to be really important and exactly what membership we keep, what membership in what products, in what geographies is really going to be important as we think about that mix and what that trend baseline going into next year will be.

Justin Lake

That's helpful. You mentioned the mix of membership. You mentioned the market exits. We're getting through open enrollment here, right, a little more than halfway through it, it feels like. So where are we -- where are -- what are you seeing in open enrollment versus what you would have expected? And how does it affect your view of next year?

Tom Cowhey

So, we talked about on the call that we think the aggregate book would be down about 5% to 10%. And -- so the book is about 4.5 million members, plus or minus, about 1.4 million of those are group members, which will be pretty stable. So that's a higher percentage decline on the individual and the D-SNP members inside the Medicare book. I'd say where we are right now based on our early reads, we'll be within that range and probably start out somewhere in the middle. We may push a little bit up into that range over the course of the year.

But I still think that's a pretty good range and consistent with what we talked about. The mix of what we're seeing might be slightly different than we originally anticipated. We're seeing a little bit of pressure on our D-SNP sales. And we're seeing a little bit better retention assumption on some of those new plans. I think we were more conservative in our resale assumptions than some of my peers. And so, we're seeing a little bit more pull-through on some of those resells. Net-net, we feel pretty good about where we are and how our strategies are playing out in the marketplace.

Justin Lake

Got it. And one thing I wanted to touch on was the -- one of the most surprising things I've heard from you is the fact that it doesn't sound like the new members are running at MLRs that are significantly higher, right, than the existing book you had, right? So, I think everyone assumes, right, that there's some bolus of membership that's just rolling across the industry and looking for the best set of benefits in a given year, and they're going to walk away from you this year potentially and go to someone else and end up being a problem. It doesn't sound like that at least from a new membership perspective is significantly different than what you would have expected relative to -- new membership relative to existing. Can you expand on that a little bit for us? Tell us what you're seeing there?

Tom Cowhey

Yes. As we -- one of the ways that we historically look at this is we take a look at what are -- what's our most complete period in terms of claims, which as of the third quarter would have been year-to-date, June effectively. And as we look at that, we look at the new members and those new member cohorts. We look at their MBRs versus what our existing book is, and we look at what the differentials are.

And I'd say relative to history, it's actually in line, which suggests this is mostly an all boats rising issue. I would say a lot of the new members that we attracted this year are sicker. We did see a lot of growth in D-SNP. But they also -- as we talked about earlier in the year, a lot of them were switchers rather than new to Medicare, so they came with existing revenue that helped to offset that and keep the MLRs in line. So that's where, as we've evaluated this, this is why we've talked a lot about how we think that the -- there's a couple of things going on inside the operations.

Number one, we priced aggressively and we priced through Stars. We grew that growth, I think, came with individuals that were interested in specifically using those supplemental benefits, which they have. I think that level of growth and also the level of inpatient growth that we've seen this year, just in pure case claims, combined with the pressure from to midnight, which has put a lot of stress on our operations. And so, as you think about Aetna-specific issues. I think there's a supplemental benefit attraction. There's -- and then there's the volume that pressured some of the operations because it takes probably 3 months to 5 months to get a case nurse up to speed, and we weren't appropriately staffed for all that volume at the beginning part of the year.

And so, I think we're in a much better place now. I think we are well positioned as we think about what expected membership levels will be next year. So, I feel much better about how those operations are currently functioning than where they were in the earlier parts of the year.

Justin Lake

Got it. When you talk about operations, it brings me to a question I've gotten occasionally, which is you've guided the 5% to 10% membership declines. You talked about a big cost-cutting program to kind of offset some of that, the SG&A impact of that. Is there a number in terms of membership declines that you get uncomfortable with from an M&A perspective, i.e., like it's going to be tougher to offset the SG&A impact there?

Tom Cowhey

No. I think the teams are well prepared for our expected levels of membership, and our current estimates are that we will be well within the range that we planned for. So, I guess if we were to decline dramatically, there would be fixed cost that we would need to go figure out how to get out, but we would go do that. We would do it aggressively. So, I feel good about how we're positioned from that perspective.

Justin Lake

And just to be clear, what visibility do you have, right? The -- in terms of I think you have pretty good visibility on your new sales. But I know CMS is always putting out with a lag, right, the members that have left you and gone somewhere else, right? How does -- what do you know at this point? What do you -- what percentage of your levers do you think you kind of have visibility into now?

Tom Cowhey

The teams are using a variety of different models by geography to determine that. I don't have the specific answer to your question, Justin. But we've spent a lot of time refining our estimates and our forecasting on membership over the course of the last 12 months, given where we landed in 2024. I feel good about the new processes that we've got in place, and I feel good about the guidance that we've given.

Justin Lake

Got it. Before I move away from the Aetna business, I'll just ask you, you're one of the few companies that has talked about commercial risk trend as seeing some acceleration. Can you tell us what you saw in 2Q and what you've seen there and kind of how you're thinking about that from a pricing and a cost perspective into 2025?

Tom Cowhey

Yes. The part of the reason for those comments was that what we saw from this first quarter to the second quarter was that trends accelerated in order of magnitude, 200 basis points to 300 basis points. And so that's pretty steep. And so, we have been for probably the last six quarters to eight quarters, pushing price. And so, as we look at what we are expecting for next year, we're going to shrink that commercial risk blocked by a couple of hundred thousand members, maybe a few hundred thousand members.

And that's a function of our not wanting to get behind on pricing. But there are -- while the pricing cycles are quicker in commercial, there are pricing cycles. And so, the ones are out right now are down the 7 1s are predominantly done. And so, as we see or if we see incremental trend pressure, the rates are, for the most part, locked for last year. And so, we wanted to highlight for folks. If we were to continue to see pressure on that book, it will -- it could not only pressure our ability to grow earnings, it could actually shrink margins in that business next year.

And so, we -- in the interest of not surprising anyone, we wanted to make sure that we were transparent about what we were seeing. October trends in commercial seem to be holding. The third quarter was a little bit better than the second, but I'd like to see more improvement there before I got more comfortable about what the outlook on that business might be.

Justin Lake

Are you seeing your peers also push price out there? Or do you feel like they're pricing to more normal trend?

Tom Cowhey

We're starting to see the -- a lot of this is really the Blues, right? I mean as you think about who's your competitor in group commercial, it is the Blues. They have different profit profiles than we do. So, we've started to hear anecdotally that they are also seeing pressure but we have -- part of the reason that we're expecting to shrink is because we're out in front of them in the marketplace. Partially offsetting that, we do have a lot of commercial ASC growth next year. We have a big contract that's coming in, in North Carolina. But we've also got a lot of start-up costs associated with that. And so again, I feel good about where that business is going to be over the course of the next couple of years, but we're watching it closely as we think about '25.

Justin Lake

Got it. So, there's a lot of focus on your CostVantage program at the -- on the pharmacy side. The -- I think the latest update was that you're set on pricing across most of your book, except for the two big guys, right, that are out there, the two big PBMs, or the big three -- the two of the three that you don't own.

Tom Cowhey

We got one of them.

Justin Lake

Yes, you got one early, I bet.

Tom Cowhey

Not that early, do you like to argue on this, though.

Justin Lake

Tell me what you're here like -- how -- when should we hear more on this? And kind of where do you feel like the tone of those negotiations are going? My impression has always been that if you do get a deal with these big guys, it's probably going to be more economic -- structural changes in '25 rather than economic changes, right, because their businesses are all kind of locked up on multiyear contracts, so they don't want to give too much back. But as you look out to '26, '27, that's where you might see some of the economic kind of stabilization that you're looking for?

Tom Cowhey

I think that's consistent with how we characterize '25 as being a transition year. So first, I would highlight that one of those major contracts went until some of the last weeks in December last year. So, this is not atypical that you're contracting with between the PBM and CVS Pharmacy would go late into the year. So, I wouldn't read into the fact that we don't have a signed contract on some of these as anything other than ordinary course. I would characterize the conversations as constructive.

And I think that we have good alignment, but we obviously need to get over the finish line with both of them. The -- I think it's -- I think that part of what we are really focused on for '25, which is consistent with your comment, is we want to transition to this new model. We talked about this a lot at Investor Day. So, our government businesses has got different pricing models. But for the commercial business, we have gotten to the point where we are 90-plus percent generic dispense rates because of the way that the incentives have been built into the pricing model, which has led us to a place over the course of a decade where we make most of our money in the pharmacy on a subset of generic prescriptions.

So, we're losing money on some of the generics we fill, and we're losing money on pretty much every branded prescription that we fill. And so, part of the advantage of CostVantage is that we will level the playing field. This will be about acquisition cost plus a small markup, plus an administration fee or dispensing fee. And so that model makes us indifferent to the type of script that we fill at the CVS store.

So, I think that in and of itself, that transition of that model is a real positive for the underlying fundamentals of that business. And if that comes with some erosion in excess of our cost of goods, I think that's okay as we move and get people used to this model. We've had good traction on the other side with David Joiner on the Caremark side, where we have about 70% of our clients that have implemented at least one of the elements of TrueCost, so that you'd start to see that end-to-end transparency between what it is that we're charging the PBM and what the PBM is asking us to adjudicate for the client at the point of sale.

So that's a real positive. And then I think we've started then to expose what the acquisition costs are, and we'll think about how we transition that model going into '26 with our commercial clients and whether or not we can arrest that rate of erosion.

Justin Lake

Got it. Maybe flipping over to the HSS business, your guidance there for 2025 or at least your -- where you kind of talked to people to in terms of earnings growth is more in kind of the mid-single-digit range, in the mid- to high single-digit range. So, my bridge is 5% rather than 6%, 7%, 8%. You talked about some conservatism there. You also talked about the fact that the first quarter started off a little bit different than you expected this year, and that's part of the reason for your conservatism. So maybe start off there. What was -- what happened in the first quarter of '24 that left you uncertain on the trajectory of that business? What got better as you went through the year? And how are you thinking about 2025 there?

Tom Cowhey

So, part of what was different in '24 was really we had -- we lost one major client. And that client, when you're pulling out that number of scripts, the rebalancing of all of our client guarantees across the multiple networks that we manage was -- it got off to a little bit of a slow start, and we talked about this in the first quarter. The -- those teams have -- we're committed to hitting their numbers, and they have really, I think, done an exceptional job of executing over the remainder of this year. We have also seen specialty growth.

But I would just say we had a little bit of a rocky start this year, from a guidance perspective, if nothing else. We pulled that down a little bit. We gave a little bit back in the second quarter. And I think it's prudent to not get ahead of ourselves as we think about 2025. I'd say fundamentally, I feel good about where that business is and is going. And we've had some strong client wins. And we also have inside that segment, the healthcare delivery business.

I think there are multiple elements of that, that should improve as we think about 2025, particularly some of the pressures that we're seeing in Oak Street, whether that's from planned bid potentially getting better, but we also have another URV28 implementation. But I think that -- net-net, I think we want to make sure that we don't whipsaw investors and that we give them numbers that we -- that have a reasonable opportunity for upside.

Justin Lake

All right. Well, I think we'll close there. Tom, I really appreciate you being here. I'll be back in a couple of hours with UHS, and thanks, everybody. Appreciate it.

Tom Cowhey

Thank you all.