Elevance Health, Inc. (ELV) Earnings Call Transcript & Summary

Well, welcome, everybody. We're happy to have Elevance Health participating in the conference again this year. Mark Kaye, EVP and Chief Financial Officer; and Nathan Rich, VP of Investor Relations. So thanks, everyone, and thanks for the perseverance to get here through a tough travel and for everyone working on the -- with the new schedule.

So Mark, the Street seems to be assuming that your 2026 EPS will be flat with 2025 as the growth in the commercial and Carelon and MA margin and HIX margin will just offset the $2.50 or so of incremental headwind in Medicaid. So people seem to be gravitating towards, basically, a $27 EPS number when you make those adjustments versus a normalized the 2025 EPS run rate. I know you haven't given guidance, but is there anything you can say that people should be taking into account that they're not?

Thanks so much, A.J. Really appreciate yourself and UBS hosting us at the conference. And that's a great question. It's a super place for us to start the conversation today. As you noted, we will be providing earnings guidance when we report our fourth quarter results in January. So let me maybe start with the areas that are in our control and where we see several tailwinds. First, commercial performance remains strong. We have anticipated higher trend levels, and we've priced for them. We also experienced strong momentum in national account sales and expect continued growth in fee-based relationships. Second, in the ACA market, 2026 rates were filed to reflect the higher acuity that we've seen this year, and we've prioritized the long-term sustainability even if membership is lower. And third, in Medicare Advantage, we took disciplined and deliberate actions for 2026, including refining our product portfolio, sharpening our focus on dual special needs plans and exiting select markets that were not aligned with our strategy. And these steps really position us to deliver the greater value or greatest value to members over their lifetime to enable us to grow sustainably over the long term and really to drive meaningful progress towards our target margin range in 2026 and beyond. Balanced against those positives, there are a few known headwinds. The largest is Medicaid, where we continue to see elevated utilization and rate misalignment, and we're working actively to address that. Our initial view for our 2026 operating margin is to decline at least 125 basis points year-over-year from a margin of approximately negative 50 basis points this year. Within Carelon, while we continue to expand solutions to our health plans, and we see strong demand from external clients, growth will be tempered by the still evolving enrollment dynamics in our health benefits business. And we appreciate the interest that investors have on potential outcomes, and while our view on membership is not final, we wanted to offer some thoughts here. And specifically, our preliminary planning assumption for our 2026 CarelonRx operating margin will be in the mid-5% range. That's a modest step down year-over-year, but it reflects the expected impact of health benefits membership changes, specifically in ACA. And then finally, we're investing several hundred million dollars to build out our digital and AI capabilities, expand Carelon and then further strengthen our performance. So when I think about next year from a high level, 2026 is really about executing across our business and taking actions to absorb the headwinds in areas outside of our control as our pricing, our care management and our technology investments begin to take hold.

Okay. Thanks. I think you reiterated your long-term growth algorithm of at least 12% compound annual EPS growth. Wherever we end up for '26, is it reasonable to think that the 12% target could be achievable for '27? It sounds like the company sees Medicaid low on margin as being in '26. So it could become a swing to a tailwind in '27.

Yes. A couple of items to parse here. But we continue to be confident in the fundamental earnings power of our diversified businesses and in our long-term growth algorithm, which, as you noted, is for at least 12% adjusted EPS growth on average over time. And to be clear, this reflects a multiyear CAGR, which means growth below 12% in some years, as we've seen recently, while other years will be above that level. And so as I think about 2026, it's going to be a year of transition and execution as well as meaningful progress. We're repositioning of the ACA business to reflect the higher market acuity and potential risk pool shifts next year. Our product orientation in Medicare Advantage is disciplined. It's focused on long-term sustainability, and we took a prudent stance on our trend in our commercial group pricing. And these actions are going to collectively allow us to build that foundation for margin improvement across our lines of business, buttressed by operating leverage and disciplined capital deployment.

Okay. And you referred to this earlier, maybe talk about Medicaid for a minute. The company is now anticipating a negative 0.5% operating margin in '25 and at least a further 125 basis points decline in '26, implying that the margin could drop to minus 1.75% you're calling that a prudent starting point and you're looking for incremental information by late January. What incremental information will the company have by then?

Yes, that's an important question. We approached our 2026 outlook by anchoring to the factors we can control, managing cost trend, driving operational efficiency and positioning the business for sustainable growth. And where uncertainty exists, we have provided our initial planning assumptions to help frame our expectations. And so as I think about what we'll learn between now and when we set official guidance, we'll receive final rates for the portion of our premiums that reset in January, which is about 1/3 of our full Medicaid revenue. We'll have an additional 3 months of cost trend information. October results were in line with our expectations. And as reflected in our Form 8-K that we filed last night, we reaffirmed our full year guide. And then finally, we continue to take actions to identify and impact areas of elevated trend as we work with the states to reduce underlying and improve program sustainability. And with this added visibility, we'll be better positioned to set 2026 guidance in January that is grounded in what we know and focus really on what we can control.

Okay. Does the negative 1.75% operating margin assume that the Medicaid cost trend stays about the same year-to-year and the rate increases remain about what they've been, and therefore, you're not closing the margin gap relative to the 2% to 4% long-term target?

Yes. I appreciate the opportunity to discuss the assumptions underpinning our outlook for Medicaid margins in greater detail. The decline in our Medicaid margin of at least 125 basis points in 2026 contemplates that cost trend levels remain at a level consistent with our expected experience in the fourth quarter and that rate increases remain below that cost level. So more specifically, you can think about medical cost trend as anticipated to increase in the mid-single-digit percent range. And we're planning for a composite rate increase also in the mid-single-digit percent range, though below that expected trend level. Importantly, we continue to take actions to help states manage costs, including tightening medical care management, expanding behavioral health interventions, strengthening specialty drug management and optimizing sites of care. And we expect these efforts to have a more meaningful impact as 2026 progresses. And our efforts, combined with the rates that are going to increasingly reflect underlying trend, underpin our belief that Medicaid margins will trough in 2026 before improving in 2027.

Okay. To that point, what gives the confidence that '26 will be the trough given that the work rules under Medicaid come in, in '27?

Yes. We've received this question a lot in the weeks since we reported. So let me outline why we believe 2026 will be the low point for Medicaid margins. First, we're taking decisive actions to improve affordability across several key levers like improving care management, deepening value-based arrangements and scaling digital and AI tools to close care gaps and streamline administrative workflows. Second, rates should begin to catch up with cost trends as states incorporate more recent experience, which remains elevated into those base rates. And then third, while we recognize that the provisions included in the budget reconciliation bill will present a headwind, we expect the impact to phase in over time as implementation time lines vary across states. Also, some of the eligibility tightening that we're already seeing could be pulling forward part of the effect from these future provisions, reducing the incremental impact in the later years. And so I'd say our 2026 outlook is intentionally prudent. It's meant to establish a credible foundation for improvement in 2027 and beyond.

Okay. Just broadly, why are the rates lagging the trend? When do you expect rate adequacy to improve?

Yes. Let me share with what we're seeing in our Medicaid book and why we're confident rates will come back into alignment with cost trends over time. As you know, state rate setting processes typically rely on experience periods that lag current trends by up to 12 to 24 months. And historically, that approach has worked well in a stable cost environment where medical trends ran in the low single-digit percent range. But in today's environment where trends accelerated sharply and then remain high, that lag has led to a material timing mismatch between rates and the actual cost of care, which, as you know, is impacting our results. Overall, I would say states are aware of this timing mismatch dynamic. And in many cases, we're now seeing rate actions begin to better reflect higher costs as that newer claims data flows through the actuarial processes. And accordingly, as states begin to then incorporate 2025 and 2026 experience into upcoming rate cycles, we expect rate adequacy to improve meaningfully heading into 2027. And then at the same time, of course, our targeted cost interventions will help lower total program costs and really enhance that long-term sustainability for our state partners.

Okay. Sort of along the same line, we step into '26, '27 and some states implement work requirements or enhanced checks on Medicaid eligibility. How are you thinking about that and whether that could lead to disenrollment that's higher than you anticipate because of those checks?

It's a good question. So early on, there was definitely the expectation that some states might move more quickly to implement work requirements, possibly as early as 2026. Where we stand today, it appears that's less likely to occur as formal rules have yet to be finalized and states will need time to implement work requirements. That said, we have already seen many states alternatively take steps to tighten eligibility and apply more stringent verification processes. And the effect of those actions are evident in the membership declines that we've seen throughout 2025. Looking ahead to 2026, we expect the enrollment pressure to continue as states further refine eligibility roles. We also expect lower enrollment to raise overall population acuity, which will pressure the gap between rates and medical cost trends that we just spoke about. Importantly, that expectation is already factored into our outlook for next year's margin. And then by 2027, our view certainly is that states are going to begin implementing the provisions of the budget reconciliation bill, including work requirements. And those changes will certainly place additional pressure on membership, but we do expect that overall impact to be manageable for some of the reasons I mentioned a minute ago. And so for our part, look, we're going to continue to partner closely with the states to navigate these transitions thoughtfully, ensuring really that continuity of care for the members, supporting states as they look to achieve program sustainability and then overall, just maintain integrity and stability.

So as you think about staying in various Medicaid programs, I think the commentary from the company has been typically that as long as you are paid actuarially sound rates, you will power through. But we've seen now this elongated period where rates have not been matched trend. Is there a point where the company begins to exit certain states due to how long it is taking?

We remain fully committed to the Medicaid program for the long term. It's a vital part of our mission. It's an important growth platform for the enterprise, but we are prepared to exit if a market is not financially sustainable through an enterprise lens. And to evaluate this decision, we're utilizing a comprehensive framework that looks at rate adequacy versus trend, historical performance, program design and stability, network and operational requirements as well as the broader regulatory landscape. We're also considering the integration that will be required to serve dually eligible populations and our ability to optimize Carelon's capabilities for this population. And if following that evaluation, it becomes clear that it will not be financially viable to remain in the market, we will make the decision to exit. Importantly, states need stable partners, and they need those stable partners to ensure program continuity and access for beneficiaries. And so pushing margins below sustainable levels for extended period will result in plan exits and service disruption. And that's outcomes nobody wants. And that's really why we are working so closely with the states to ensure rates return to actuarial soundness and reflect current population acuity and cost trends.

Okay. As you think about the underlying cost trend dynamics in Medicaid, why is utilization trend or trend in behavioral or specialty drugs rising so much? Is there a breakpoint where states have to adjust benefit design? And similarly, how would this translate to you as the capitation rate will presumably drop if benefits are reduced?

It's a great question. So both behavioral health and specialty drugs are big drivers of the higher levels of cost that we have seen. In behavioral health, utilization continues to rise as access and awareness expands, the stigma around mental health services subsides and more conditions are being diagnosed and treated. We're also seeing broader benefit coverage and integration of behavioral health across key management programs. which, while positive for members, does add pressure on utilization beyond what many states originally anticipated. On the pharmacy side, specialty drugs remain a key driver of medical trend as new high-cost therapies come to market and existing drugs gain expanded indications. And these treatments are clinically valuable but significantly more expensive, which increases the overall cost intensity. From the state's perspective, elevated trend has increased interest in program changes. And as a company's strategy is really focused on improving affordability, we are at the forefront of helping states lower costs. And that means we're addressing cost pressure proactively. We're improving utilization management. We're curating high-value networks. And we're expanding value-based care programs through Carelon. And these interventions really help reduce unnecessary utilization while ensuring members continue to receive medically appropriate high-quality care.

When you think about the fact that you're operating at a 0.5% negative operating margin, Medicaid anticipating it worsens next year, how do you look at the G&A load associated with that business? Is it where you believe it should be, given how much absolute enrollment has declined?

I appreciate that question. Membership declines naturally create some G&A pressure through deleveraging. But we've been proactively addressing that, and we feel good about where we are today. Broadly speaking, there's still opportunity to reduce expense levels associated with managing Medicaid populations. And some of that is structural. Smaller, higher acuity programs like LTSS carry inherently higher expense loads because of the staffing and operational requirements states mandate to support those members. And we are working closely with states to modernize those requirements and see significant potential to embed more digital and AI-driven solutions that can lower the cost to serve these members while at the same time, maintaining the high quality of service that the states expect. So to your specific question, we feel good about our current G&A levels in Medicaid, and we've taken deliberate action to align our cost structure with the evolving membership base. And then over time, we do believe there's meaningful opportunity for innovation across the industry, and we're very, very focused on leading that effort.

Okay. Maybe to pivot over to Carelon for a minute or 2. I think the company anticipates a strong external growth heading into next year, but at the same time, suggested the enrollment impact on the exchanges and in Medicaid could impact growth here. Is there a way to dimension these impacts?

Yes. We'll provide our full year outlook for Carelon in January once we have greater clarity around membership levels, particularly as we move through the Medicare annual election period. and open enrollment on the exchanges. And these figures, they're going to help shape our view looking forward. And so we'll size any specific implications accordingly in our actual 2026 guidance. At this time, and as I briefly mentioned earlier, we do expect CarelonRx operating margin to be in that mid-5% range next year. And that reflects both anticipated membership changes in health benefits, particularly in ACA and targeted investments to scale our specialty and digital capabilities. And so with that in mind, let me maybe offer just a few broad points to help frame the relationship between our health benefits membership and our Carelon performance. Now first, earnings mix. So Carelon's affiliated earnings mix by insurance line broadly mirrors the enterprise, meaning we generate more earnings from commercial, particularly group than from government programs. Second, margin profile. Carelon's margins generally track the target margin profile of the health benefits line that we support, meaning they're higher in commercial, lower in government. And then third is revenue mix. So here, think about affiliated revenue mix is aligned with the health benefits premium distribution by line of business. So in summary, I'd say that in today's high-cost environment, we're seeing strong demand for Carelon's differentiated capabilities. Clients are looking for partners who can manage complex cost and quality challenges and Carelon's integrated solutions are resonating.

Okay. With one of your -- specifically on CarelonRx, one of your peers has introduced what they're calling as a rebate-free PBM model. What do you anticipate that this means for the future of the PBM market?

Yes, that's a super question. So we certainly understand the interest in how the PBM market may evolve. So let me talk about Carelon's strategy. So we've built CarelonRx for long-term durability and adaptability. The strength of our pharmacy model lies in driving affordability through deep integration of pharmacy into whole person care, the coordinated management of high-cost therapies and proactive member engagement. And these are the areas where we're investing and where we're seeing results with up to $100 per member per month savings when incentives are aligned. Our contracting framework also provides plan sponsors with meaningful optionality in how they engage with us, enabling each client to align its pharmacy benefit structure with its broader benefit strategy. And that gets back to an essential point I want to make sure that affordability is paramount. And that's why we've led the way in transparency and value by providing net pricing at the point of sale for our commercial fully insured members since 2020. And this approach really helps members make those more informed decisions and experience meaningful savings at the pharmacy counter. So in our view, these industry changes simply reinforce the integrated approach that we have already established. And CarelonRx is all about transparency and affordability, and that's very well aligned with where the PBM market is heading and further supported by, I'd say, the differentiated enterprise capabilities that we're building out across Elevance Health.

Okay. When you think about the evolution of issues like rebates and spread pricing, can you talk about how much exposure you have to these? And what are some of the differences and nuances to consider in terms of what you bring to market versus peers?