MOH

Business Context and Reporting Period

Company: Molina Healthcare, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Overview: Molina is a multi-state managed care organization participating exclusively in government-sponsored health care programs (Medicaid, CHIP, and limited Medicare) for low-income persons. Operations are conducted through 10 licensed health plans in California, Florida, Michigan, Missouri, Nevada, New Mexico, Ohio, Texas, Utah, and Washington.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Premium revenue increased 22% in the second quarter and 19.6% year-to-date compared to 2008, driven by an 11% increase in total membership (1,368,000 members) and higher per-member-per-month (PMPM) rates.
• Profitability Decline: Net income decreased 8% in the second quarter and 5% year-to-date compared to 2008. Operating income declined 32% in the quarter and 18% year-to-date.
• Medical Cost Increases: Medical care costs rose 14% on a PMPM basis in the quarter, attributed to higher utilization (specifically emergency room visits) and the impact of the H1N1 influenza outbreak. The medical care ratio worsened to 86.8% (Q2) and 86.4% (YTD) from 84.2% and 85.0% in the prior year periods.
• Investment Income: Investment income dropped 61% in the quarter and 56% year-to-date due to lower interest rates.
• Tax Rate: The effective tax rate decreased significantly to 16.8% (Q2) and 29.9% (YTD) from 41.0% and 40.9% in 2008, primarily due to $4.4 million in discrete tax benefits from settling examinations and changing accounting methods.

Guidance, Outlook, and Risks

• Contract Renewals: Missouri and Michigan Medicaid contracts were renewed. A tentative award was received for a Texas CHIP contract covering 170 rural counties, effective September 2010.
• California and Washington Performance: Results in California were pressured by a $5.2 million underestimation of claims reserves at year-end 2008. Washington results deteriorated due to a 7.5% rate cut in July 2009, with only one-third of the revenue reduction offset by lower medical costs.
• Utah Transition: The Utah health plan is transitioning from a cost-plus reimbursement model to a prepaid capitation contract effective September 1, 2009, introducing new medical cost risk.
• Capital Actions: The company repurchased $27.7 million of common stock and $9.8 million of convertible senior notes year-to-date. A $25 million securities purchase program remains active through December 31, 2009.
• Key Risks: Risks include budgetary pressures on state governments, the illiquidity of auction rate securities ($70.1 million par value), potential reversals of recognized tax benefits, and the inability to pass rate cuts to providers.

Investor Verification Checklist

• Claims Reserve Adequacy: Verify the $5.2 million adverse development in California and the methodology for estimating Incurred But Not Paid (IBNP) liabilities, which are sensitive to completion factors and trended PMPM costs.
• Auction Rate Securities: Assess the liquidity risk and fair value of $70.1 million in auction rate securities, which have experienced failed auctions and are valued using Level 3 inputs.
• Tax Benefit Sustainability: Confirm the permanence of the $4.4 million discrete tax benefit and the risk of reversal regarding the IRS settlement related to the Michigan Cape Health Plan acquisition.
• Washington Rate Cut Impact: Monitor the ability to pass the 7.5% rate cut to providers to prevent further margin erosion in the Washington health plan.
• Utah Capitation Transition: Evaluate the financial impact of the Utah plan's shift to a risk-based capitation model starting September 2009.