CENTENE CORP (CNC) FY 2022 MD&A

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this filing. The discussion contains forward-looking statements that involve known and unknown risks and uncertainties, including those set forth under Part I, Item 1A."Risk Factors" of this Form 10-K. The following discussion and analysis does not include certain items related to the year ended December 31, 2020, including year-to-year comparisons between the year ended December 31, 2021 and the year ended December 31, 2020. For a comparison of our results of operations for the fiscal years ended December 31, 2021 and December 31, 2020, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 22, 2022.

EXECUTIVE OVERVIEW

Mission

We are a leading healthcare enterprise, committed to helping people live healthier lives, with an established expertise in lower-income and medically complex populations. We provide access to high-quality healthcare, innovative programs, and a wide range of health solutions that help families and individuals get well, stay well, and be well. We believe that our local approach enables us to provide accessible, quality, culturally sensitive healthcare coverage to our communities.

We feel we have a competitive advantage being on the ground, enabling us to establish strong relationships with our partners and providing us with first-hand knowledge, which allows us to provide the best possible care to our members. We have a commitment to the communities and people we serve to transform their health at the local level. In 2022, when members of the Uvalde, Texas community faced unbelievable tragedy, we showed up to help serve their short-term needs and have since made an investment in a multipurpose community center in the city through our charitable foundation, just one example of our mission in action.

Our record of organic growth and strategic acquisitions has given us the size, scale, and privilege of providing local high-quality and affordable health care to more than 27 million Americans. As of December 31, 2022, we were the largest Medicaid health insurer in the country, serving 16 million Medicaid recipients in 29 states. We were the largest Marketplace carrier, serving 2.1 million members across 27 states, and served 1.5 million Medicare members across 36 states, with the highest concentration of lower-income, medically complex members.

While we are transforming our operating model to take advantage of our national scale, our commitment to remain local in the communities we serve will not change.

General

Our results of operations depend on our ability to manage expenses associated with health benefits (including estimated costs incurred) and selling, general and administrative (SG&A) costs. We measure operating performance based upon two key ratios. The health benefits ratio (HBR) represents medical costs as a percentage of premium revenues, excluding premium tax revenues that are separately billed, and reflects the direct relationship between the premiums received and the medical services provided. The SG&A expense ratio represents SG&A costs as a percentage of premium and service revenues, excluding premium taxes separately billed.

Value Creation Plan

We established our Value Creation Plan to drive margin expansion by leveraging our scale and generating sustainable, profitable growth. In addition to creating shareholder value, this plan is an ongoing effort to modernize and improve how we work in order to propel our organization to new levels of success and elevate the member and provider experiences. The three major pillars of the Value Creation Plan are: SG&A expense savings, gross margin expansion, and strategic capital management.

As part of our Value Creation Plan, we are assessing our portfolio and are focused on making strategic decisions and investments to create additional value in the short-term and to seek opportunities that position the organization for long-term strength, profitability, growth, and innovation. We continue to move forward with our value creation initiatives including the streamlining of certain operations, such as key call centers and utilization management, and have begun early-stage platform consolidations. Building on that foundation, we intend to drive sustainable, profitable growth and long-term value to our members and shareholders.

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During 2022, we completed the following key milestones in our Value Creation Plan:

•Initiated a reduction of our real estate footprint following a strategic review of our real estate portfolio resulting in a $1.6 billion impairment related to leased and owned real estate and related fixed assets. This represents an approximate 70% decrease in domestic leased space and is expected to result in annualized lease expense savings of more than $200 million.

•Signed a multi-year contract with Express Scripts, Inc. to provide our pharmacy benefit services, commencing in 2024. The new pharmacy benefits management (PBM) contract is expected to drive significant value in 2024 and beyond.

•Completed the divestitures of PANTHERx Rare (PANTHERx), our Spanish and Central European businesses, and Magellan Rx.

•Completed $3.0 billion of common stock repurchases, $318 million of senior note repurchases, repaid our $180 million construction loan, and repaid over $100 million in revolver and term loan borrowings. Common stock and debt repurchases were funded primarily through proceeds from divestitures and free cash flow generated from operations.

In addition, in January 2023, we completed the divestitures of Magellan Specialty Health, Centurion, and HealthSmart.

Segments Update

In early 2023, and in conjunction with our updated strategic plan, executive leadership realignment, and corresponding 2023 divestitures, we have revised the way we manage the business, evaluate performance, and allocate resources, resulting in an updated segment structure comprised of (1) a Medicaid segment, (2) a Medicare segment, (3) a Commercial segment and (4) an Other segment. We will begin reporting under this new segment structure in 2023.

Acquisitions and Divestitures

In January 2022, we acquired all of the issued and outstanding shares of Magellan Health, Inc. (Magellan). Total consideration for the acquisition was $2.5 billion, consisting of $2.4 billion in cash and $60 million related to the fair value of replacement equity awards associated with pre-combination service.

In connection with our portfolio review and strategic plan to exit the PBM business, during 2022 we divested PANTHERx and Magellan Rx. We completed the divestiture of PANTHERx in July 2022 for $1.4 billion and recognized a gain of $490 million, or $382 million after-tax. In December 2022, we completed the divestiture of Magellan Rx for $1.3 billion and recognized a gain of $269 million, or $99 million after-tax.

Additionally, as part of our review of strategic alternatives for our international portfolio, in November 2022 we divested our ownership stakes in our Spanish and Central European businesses and as a result recorded an impairment charge of $163 million, or $140 million after-tax.

The above-noted acquisitions and divestitures are significant drivers of the year-over-year variances discussed throughout this section.

In January 2023, we completed the divestitures of Magellan Specialty Health, Centurion, our prison healthcare business, and HealthSmart, our third party health plan administration business.

Regulatory Trends and Uncertainties

The United States government, policymakers, and healthcare experts continue to discuss and debate various elements of the United States healthcare model. We remain focused on the promise of delivering access to high-quality, affordable healthcare to all of our members and believe we are well positioned to meet the needs of the changing healthcare landscape.

In contrast to previous executive and legislative efforts to restrict or limit certain provisions of the Affordable Care Act (ACA), the American Rescue Plan Act (ARPA), enacted in March 2021, contained provisions aimed at leveraging Medicaid and the Health Insurance Marketplace to expand health insurance coverage and affordability to consumers. The ARPA authorized an additional $1.9 trillion in federal spending to address the COVID-19 public health emergency (PHE), and contained several provisions designed to increase coverage of certain healthcare services, expand eligibility and benefits, incentivize state Medicaid expansion, and adjust federal financing for state Medicaid programs, the ultimate impact of which remain uncertain.

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The ARPA initially enhanced eligibility for the advance premium tax credit for enrollees in the Health Insurance Marketplace, which was extended through the 2025 tax year by the Inflation Reduction Act, enacted in August 2022.

In October 2022, the Treasury Department issued a final rule to address the family glitch in the ACA, which relates to determining who is eligible for premium subsidies. We see this as a significant step in making Marketplace more affordable for working families.

The COVID-19 pandemic has impacted and may continue to affect our business. The Families First Coronavirus Response Act, enacted in March 2020, increased federal matching rates for state Medicaid programs with a requirement that states suspend Medicaid redeterminations throughout the PHE. As a result, since the onset of the PHE, our Medicaid membership has increased by 3.2 million members (excluding the new North Carolina and Missouri membership). The Consolidated Appropriations Act, 2023, signed into law on December 29, 2022, delinked the Medicaid continuous coverage requirements from the PHE and, as a result, states can begin Medicaid disenrollments on April 1, 2023. All pending redeterminations must be initiated within 12 months, by March 31, 2024, and be concluded by May 31, 2024. Our Ambetter Health product covers the majority of our Medicaid states, and we believe we are among the best positioned in the healthcare market to capture those transitioning coverage through redeterminations. We remain agile in working with our state partners and are prepared to support our members and promote continuity of coverage when redeterminations resume. Although Medicaid continuous coverage requirements were decoupled from the PHE, we are working to prepare for other provisions still tied to the end of the PHE including COVID costs and coverage requirements, various other payment structures, and electronic prescribing of controlled substances.

We have more than three decades of experience, spanning seven presidents from both sides of the aisle, in delivering high-quality healthcare services on behalf of states and the federal government to under-insured and uninsured families, commercial organizations, and military families. This expertise has allowed us to deliver cost-effective services to our government sponsors and our members. While healthcare experts maintain a focus on personalized healthcare technology, we continue to make strategic decisions to accelerate the development of new software platforms and analytical capabilities. We continue to believe we have both the capacity and capability to successfully navigate industry changes to the benefit of our members, customers, and shareholders.

For additional information regarding regulatory trends and uncertainties, see Part I, Item 1 "Business - Regulation" and Item 1A, "Risk Factors."

2022 Highlights

Our financial performance for 2022 is summarized as follows:

•Year-end membership of 27.1 million, an increase of 1.2 million members, or 5% over 2021.

•Total revenues of $144.5 billion, representing 15% growth year-over-year.

•Premium and service revenues of $135.5 billion, representing 15% growth year-over-year.

•HBR of 87.7% for 2022, compared to 87.8% for 2021.

•SG&A expense ratio of 8.6% for 2022, compared to 8.1% for 2021.

•Adjusted SG&A expense ratio of 8.4% for 2022, compared to 7.9% for 2021.

•Diluted earnings per share (EPS) of $2.07 for 2022, compared to $2.28 for 2021.

•Adjusted diluted EPS of $5.78 for 2022, compared to $5.15 for 2021.

•Operating cash flows of $6.3 billion, or 5.2 times net earnings, for 2022.

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A reconciliation from GAAP diluted EPS to Adjusted Diluted EPS is highlighted below, and additional detail is provided under the heading "Non-GAAP Financial Presentation":

(1) Other adjustments include the following pre-tax items:

2022:

(a) real estate impairments of $1,642 million, or $2.82 per share ($2.08 after-tax); PANTHERx divestiture gain of $490 million, or $0.84 per share ($0.65 after-tax); impairments of assets associated with the divestitures of our Spanish and Central European, Centurion, and HealthSmart businesses of $458 million, or $0.78 per share ($0.60 after-tax); Magellan Rx divestiture gain of $269 million, or $0.46 per share ($0.17 after-tax); Health Net Federal Services asset impairment of $233 million, or $0.40 per share ($0.39 after-tax); gain on debt extinguishment of $27 million, or $0.04 per share ($0.03 after-tax); increase to the previously reported gain on the divestiture of U.S. Medical Management (USMM) due to the finalization of working capital adjustments of $13 million, or $0.02 per share ($0.02 after-tax); and costs related to the PBM legal settlement of $6 million, or $0.01 per share ($0.00 after-tax).

2021:

(b) PBM legal settlement expense of $1,264 million, or $2.14 per share ($1.76 after-tax); gain related to the acquisition of the remaining 60% interest of Circle Health of $309 million, or $0.52 per share ($0.52 after-tax); impairment of our equity method investment in RxAdvance of $229 million, or $0.39 per share ($0.32 after-tax); gain related to the divestiture of USMM of $150 million, or $0.25 per share ($0.23 after-tax); debt extinguishment costs of $125 million, or $0.21 per share ($0.16 after-tax); reduction to the previously reported gain on divestiture of certain products of our Illinois health plan of $62 million, or $0.10 per share ($0.08 after-tax); and severance costs due to a restructuring of $54 million, or $0.09 per share ($0.06 after-tax).

(2) The income tax effects of adjustments are based on the effective income tax rates applicable to each adjustment. In addition, the year ended December 31, 2022, includes tax expense of $107 million, or $0.18 per share, related to the Magellan Specialty Health divestiture and a $15 million, or $0.03 per share, tax benefit related to the RxAdvance impairment.

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Current and Future Operating Drivers

The following items contributed to our results of operations as compared to the previous year:

Medicaid

•In October 2022, the state of Ohio removed pharmacy services in connection with the state's transition from managed care to a single PBM.

•In July 2022, our subsidiary, Home State Health, commenced the MO HealthNet Managed Care General Plan and Specialty Plan contracts. Under the General Plan, Home State Health continues to serve multiple MO HealthNet programs including Children's Health Insurance members and the state's newly implemented Medicaid expansion population, across all regions of Missouri. Additionally, as the sole provider of the newly awarded Specialty Plan, Home State Health now serves approximately 52,100 foster children and children receiving adoption subsidy assistance.

•In January 2022, the state of California carved out pharmacy services in connection with the state's transition of pharmacy services from managed care to fee-for-service.

•In July 2021, we began operating under two new statewide contracts in Hawaii to continue administering covered services to eligible Medicaid and Children's Health Insurance Program (CHIP) members for medically necessary medical, behavioral health, and long-term services and support and to continue administering services through the Community Care Services program in partnership with the Hawaii Department of Human Services' Med-QUEST Division.

•In July 2021, our subsidiary, WellCare of North Carolina, commenced operations under a new statewide contract in North Carolina providing Medicaid managed care services. In addition, we also began operating under a new contract to provide Medicaid managed care services in three regions in North Carolina through our provider-led North Carolina joint venture, Carolina Complete Health.

•Beginning in 2020, the federal government issued a PHE which suspended Medicaid eligibility redeterminations. The ongoing suspensions, which have been extended to April 2023, have driven increased membership.

Medicare

•In 2022, we experienced strong Medicare membership growth as a result of the 2022 annual enrollment period. We introduced WellCare into three new states, as well as expanded coverage to 327 new counties across existing states. We now serve members in 36 states across the country in 1,575 counties. We were negatively impacted by the decrease in the number of our Medicare members in a 4.0 star or above plan for the 2021 rating year (2022 revenue year).

Commercial

•In 2022, our Health Insurance Marketplace product, Ambetter Health, was introduced into five new states, as well as expanded coverage to 274 new counties across 13 existing states. During 2022, we served Marketplace members in 27 states across the country in 1,480 counties. Additionally, we introduced three new Ambetter Health product offerings to address the growing needs of our members: Ambetter Value, Ambetter Select, and Ambetter Virtual Access.

Specialty and Other

•In December 2022, we completed the divestiture of Magellan Rx, which was part of the Magellan business acquired in January 2022.

•In November 2022, we completed the divestiture of our ownership stakes in our Spanish and Central European businesses, including Ribera Salud, Torrejón Salud, and Pro Diagnostics Group.

•In July 2022, we completed the divestiture of PANTHERx.

•In January 2022, we acquired all of the issued and outstanding shares of Magellan.

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•In December 2021, we sold a majority stake in USMM, our physician home health business.

•In July 2021, we acquired the remaining interest in our equity method investment in Circle Health, one of the U.K.'s largest independent operators of hospitals.

We expect the following items to impact our future results of operations:

Medicaid

•In February 2023, our subsidiary, Buckeye Health Plan, commenced the Medicaid contract awarded by the Ohio Department of Medicaid to continue servicing members with quality healthcare, coordinated services, and benefits.

•In January 2023, our subsidiary, Delaware First Health, commenced its contract for the statewide Medicaid managed care programs.

•In January 2023, our subsidiary, Louisiana Healthcare Connections, commenced the Medicaid contract awarded by the Louisiana Department of Health to continue administering quality, integrated healthcare services to members across the state.

•In January 2023, our subsidiary, Managed Health Services, commenced the contract awarded by the Indiana Department of Administration to continue serving Hoosier Healthwise and Health Indiana Plan members with Medicaid and Medicaid alternative managed care and care coordination services.

•In December 2022, our subsidiary, Health Net of California, was selected by the California Department of Health Care Services for direct Medicaid contracts in 10 counties, including Los Angeles (in which a portion will be subcontracted). The contracts are anticipated to begin in January 2024.

•In September 2022, our subsidiary, Nebraska Total Care, was awarded the Nebraska Department of Health and Human Services statewide Medicaid managed care contract. Under the new contract, Nebraska Total Care will continue serving the state's Medicaid Managed Care Program, known as Heritage Health. The new contract term is five years and includes the option for two, one-year renewals. The contract is anticipated to begin in January 2024, subject to the resolution of third-party protests.

•In September 2022, our subsidiary, Superior HealthPlan (Superior), was awarded a new, six-year contract by the Texas Health and Human Services Commission to continue providing youth in foster care with healthcare coverage through the STAR Health Medicaid program. Superior has been the sole provider of STAR Health coverage since the program launched in 2008. The contract is anticipated to begin in September 2023.

•In August 2022, our subsidiary, Magnolia Health Plan (Magnolia), was awarded the Mississippi Division of Medicaid contract. Under the new contract, Magnolia will continue serving the state's Coordinated Care Organization Program, which will consist of the Mississippi Coordinated Access Network and the Mississippi CHIP. The contract is anticipated to begin in July 2023, subject to the resolution of third-party protests.

•In August 2021, our subsidiaries, Carolina Complete Health and WellCare of North Carolina, were selected to coordinate physical and/or other health services with Local Management Entities/Managed Care Organizations under the state's new Tailored Plans. The Tailored Plans, which are expected to launch in April 2023, are integrated health plans designed for individuals with significant behavioral health needs and intellectual/developmental disabilities.

•We expect Medicaid eligibility redeterminations to begin in April 2023 and extend over a 14-month period, concluding in May 2024. In addition to delinking the Medicaid continuous enrollment provision from the PHE, the year-end spending bill also outlines key coverage expansion provisions, including CHIP coverage. The provision requires states to provide 12 months of continuous coverage for children under Medicaid and CHIP effective January of 2024 and made the state option to extend coverage for postpartum women for up to 12 months permanent.

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Medicare

•In October 2022, the Centers for Medicare and Medicaid Services (CMS) published updated Medicare Star quality ratings for the 2023 rating year, which impacts the 2024 revenue year. The decrease in Star quality ratings is driven by the expiration of certain disaster relief provisions as well as deterioration in select metrics. Over the past year, our leadership team launched a multi-year plan to build and improve quality across the enterprise with a strong focus on enhanced patient experience and access to care. We expect to begin to see the results of these efforts with the 2024 rating year (2025 revenue year).

Commercial

•In January 2023, our Health Insurance Marketplace product, Ambetter Health, expanded into Alabama and extended its footprint by more than 60 counties across 12 existing states. In total, the Marketplace plan is available in more than 1,500 counties across 28 states.

Specialty and Other

•In January 2023, we completed the divestitures of Magellan Specialty Health, Centurion, our prison healthcare business, and HealthSmart, our third party health plan administration business.

•In December 2022, the Department of Defense (DoD) announced that the TRICARE Managed Care Support Contracts were not awarded to our subsidiary, Health Net Federal Services. Our current contract for health care delivery services is in place through early 2024.

•We continue to execute on Value Creation Plan initiatives including the award of the new PBM contract commencing in 2024, portfolio review, real estate optimization, stock and debt repurchases, along with an ongoing focus on quality improvement actions. We expect these actions will drive future margin expansion, create shareholder value, and improve the experience for our members and providers.

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MEMBERSHIP

From December 31, 2021 to December 31, 2022, we increased our managed care membership by 1.2 million, or 5%. The following table sets forth our membership by line of business:

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RESULTS OF OPERATIONS

The following discussion and analysis is based on our Consolidated Statements of Operations, which reflect our results of operations for years ended December 31, 2022 and 2021, respectively, prepared in accordance with generally accepted accounting principles in the United States (GAAP) ($ in millions, except per share data in dollars):

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Year Ended December 31, 2022 Compared to Year Ended December 31, 2021

Total Revenues

The following table sets forth supplemental revenue information for the year ended December 31, ($ in millions):

Total revenues increased 15% in the year ended December 31, 2022, over the corresponding period in 2021, primarily due to Medicaid membership growth resulting from the ongoing suspension of eligibility redeterminations, membership growth in the Medicare business, our acquisition of Magellan, and the commencement of our contracts in North Carolina in mid-2021.

Operating Expenses

Medical Costs

The HBR for the year ended December 31, 2022 was 87.7%, compared to 87.8% in 2021. The HBR for 2022 was positively impacted by disciplined Marketplace pricing and 2021 risk adjustment recorded in 2022, partially offset by a return to more normalized Medicaid utilization and higher flu costs compared to 2021. Additionally, 2021 was negatively impacted by unfavorable 2020 risk adjustment.

Cost of Services

Cost of services increased by $2.1 billion in the year ended December 31, 2022, compared to the corresponding period in 2021, driven by the acquisition of Magellan. The cost of service ratio for the year ended December 31, 2022 was 84.2%, compared to 86.4% in 2021. The decrease in the cost of service ratio was driven by recent acquisitions and divestitures.

Selling, General & Administrative Expenses

The SG&A expense ratio was 8.6% for the year ended December 31, 2022, compared to 8.1% for the year ended December 31, 2021. The Adjusted SG&A expense ratio was 8.4% for the year ended December 31, 2022, compared to 7.9% for the year ended December 31, 2021. The increases were due to the additions of the Magellan and Circle Health businesses, which operate at higher SG&A ratios due to the nature of their respective businesses. Increases were also driven by costs associated with Medicare marketing, including annual enrollment, value creation investment spending, and variable compensation. These impacts were partially offset by the leveraging of expenses over higher revenues as a result of increased membership.

Impairment

During the year ended December 31, 2022, we recorded total impairment charges of $2.3 billion primarily driven by $1.6 billion associated with our ongoing real estate optimization initiative, consisting of leased and owned real estate assets and related fixed assets. Additionally, we recorded impairment charges associated with the divestitures of our Spanish and Central European, Centurion, and HealthSmart businesses of $458 million. We also recorded a $233 million impairment charge related to Health Net Federal Services business as a result of the DoD's December 2022 announcement to not award Health Net Federal Services a TRICARE Managed Care Support Contract.

During the year ended December 31, 2021, we recorded a $229 million impairment of our equity method investment in RxAdvance, a pharmacy benefit manager.

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Legal Settlement

During the second quarter of 2021, we recorded a legal settlement reserve estimate of $1.25 billion (inclusive of the states with which we have reached no-fault agreements) related to services previously provided by Envolve Pharmacy Solutions, Inc. (Envolve), which historically provided PBM and specialty pharmacy services, essentially during 2017 and 2018.

Other Income (Expense)

The following table summarizes the components of other income (expense) for the year ended December 31, ($ in millions):

Investment and other income. Investment and other income increased by $460 million for the year ended December 31, 2022 compared to 2021, driven by the $490 million PANTHERx divestiture gain, the $269 million Magellan Rx divestiture gain, and higher interest rates on larger investment balances. The 2021 investment income was driven by the gain related to the acquisition of the remaining 60% interest of Circle Health of $309 million and the gain related to the divestiture of USMM of $150 million.

Debt extinguishment. In 2022, we repurchased $95 million of our 4.25% Senior Notes due 2027 and $223 million of our 4.625% Senior Notes due 2029 through our senior note debt repurchase program, resulting in a pre-tax gain on extinguishment of $14 million. Additionally, we recognized a $13 million pre-tax gain on the extinguishment of debt related to the refinancing of debt for our Circle Health subsidiary. The 2022 debt extinguishment also includes an immaterial gain related to the redemption of Magellan's outstanding Senior Notes in January 2022.

In 2021, we redeemed all of our outstanding 5.375% Senior Notes due 2026 and all WellCare Health Plans, Inc.'s outstanding 5.375% Senior Notes due 2026, including all premiums and accrued interest. We recognized a pre-tax loss on extinguishment of $79 million, including the call premium, the write-off of the unamortized premium and debt issuance costs, and expenses related to the redemptions. Additionally, we tendered or redeemed all of our outstanding $2.2 billion 4.75% Senior Notes, due 2025, and recognized a pre-tax loss on extinguishment of approximately $46 million. The loss includes the call premium and the write-off of unamortized premium and debt issuance costs.

Interest expense. Interest expense for the year ended December 31, 2022 was $665 million compared to $665 million for the corresponding period in 2021.

Income Tax Expense

For the year ended December 31, 2022, we recorded an income tax expense of $760 million on pre-tax earnings of $2.0 billion, or an effective tax rate of 38.8%. The effective tax rate for the year ended December 31, 2022 is driven by the tax effects of pending and completed divestitures and impairments associated with our ongoing portfolio review, including the Magellan Rx divestiture gain, the non-deductible impairment of our Health Net Federal Services business, and tax impacts related to the reclassification of the Magellan Specialty Health business to held for sale. For the year ended December 31, 2021, we recorded income tax expense of $477 million on pre-tax earnings of $1.8 billion, or an effective tax rate of 26.3%, which reflects the non-taxable gain related to the acquisition of the remaining 60% interest in Circle Health, the partial non-deductibility of the legal settlement reserve, and the gain on the sale of our majority stake in USMM.

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Segment Results

The following table summarizes our consolidated operating results by segment for the year ended December 31, ($ in millions):

Managed Care

Total revenues increased 12% in the year ended December 31, 2022, compared to the corresponding period in 2021, driven by organic Medicaid growth, primarily due to the ongoing suspension of eligibility redeterminations, membership growth in the Medicare business, and the commencement of our contracts in North Carolina. Earnings from operations increased $124 million between years primarily as a result of Medicaid and Medicare membership growth, favorable Marketplace 2021 risk adjustment recorded in 2022, and lower traditional utilization in the Marketplace business, partially offset by the $1.6 billion pre-tax real estate impairment. Additionally, 2021 was negatively impacted by the PBM legal settlement expense of $1.25 billion and higher utilization in the Marketplace business in 2021.

Specialty Services

Total revenues increased 22% in the year ended December 31, 2022, compared to the corresponding period in 2021, resulting primarily from our acquisition of Magellan, increased services associated with membership growth in the Managed Care segment, and new contracts in our correctional business. Earnings from operations decreased $590 million between years, primarily due to divestitures and impairments. The decrease was partially offset by favorable Magellan operations and the prior year impairment of our equity method investment in RxAdvance.

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LIQUIDITY AND CAPITAL RESOURCES

The following table is a condensed schedule of cash flows used in the discussion of liquidity and capital resources ($ in millions):

Cash Flows Provided by Operating Activities

Normal operations are funded primarily through operating cash flows and borrowings under our Revolving Credit Facility. In 2022, operating activities provided cash of $6.3 billion, or 5.2 times net earnings, compared to $4.2 billion in 2021. Cash flows provided by operations in 2022 were driven by net earnings before the non-cash real estate and divestiture related impairment charges and an increase in medical claims liabilities driven by the timing of claims payments.

Cash flows provided by operations in 2021 were due to net earnings before the legal settlement reserve, an increase in state risk sharing mechanism payables, partially offset by risk adjustment and minimum medical loss ratio (MLR) payments for the Health Insurance Marketplace 2020 plan year.

Cash Flows Used in Investing Activities

Investing activities used cash of $2.9 billion for the year ended December 31, 2022 and $3.3 billion in 2021. Cash flows used in investing activities in 2022 primarily consisted of net additions to the investment portfolio of our regulated subsidiaries and our acquisition of Magellan, partially offset by our PANTHERx and Magellan Rx divestiture proceeds.

We spent $1.0 billion and $910 million in the years ended December 31, 2022 and 2021, respectively, on capital expenditures for system enhancements, market growth, and our corporate and regional buildings.

As of December 31, 2022, our investment portfolio consisted primarily of fixed-income securities with a weighted average duration of 3.4 years. We had unregulated cash and investments of $1.4 billion at December 31, 2022. The majority of the excess unregulated cash and cash equivalents was utilized in January 2023 to complete planned pass-through payments. At December 31, 2021 we had unregulated cash and investments of $3.4 billion, which was substantially reduced in January 2022 to fund the Magellan acquisition. Unregulated cash and investments include private equity investments and company owned life insurance contracts.

Cash flows used in investing activities in 2021 primarily consisted of the net additions to the investment portfolio of our regulated subsidiaries (including transfers from cash and cash equivalents to long-term investments), acquisition and divestiture activity primarily related to the acquisition of the remaining 60% interest of Circle Health, and capital expenditures, offset by proceeds received related to the sale of our majority interest in USMM.

Cash Flows (Used in) Provided by Financing Activities

Financing activities used cash of $4.2 billion in the year ended December 31, 2022, compared to providing cash of $1.4 billion in the comparable period in 2021. Financing activities in 2022 were driven by stock repurchases of $3.0 billion, the redemption of Magellan's outstanding debt of $535 million assumed in the transaction using Magellan's cash on hand, senior note debt repurchases of $318 million, and the repayment of our construction loan. In 2021, financing activities were driven by increased borrowings offset by debt repayments.

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Liquidity Metrics

We have a stock repurchase program authorizing us to repurchase common stock from time to time on the open market or through privately negotiated transactions. In 2022, in preparation for the closing of divestitures as well as planning for the future, the Company's Board of Directors authorized up to a total of $6.0 billion of repurchases under the program.

In 2022, we repurchased a total of 35.7 million shares for $3.0 billion through our stock repurchase program, primarily funded through divestiture proceeds. A portion of the repurchases were completed through an accelerated share repurchase (ASR) agreement, which was executed in July 2022. At inception, we received an initial delivery of approximately 8.6 million shares representing 80% of the $1.0 billion notional amount. In October 2022, an additional 3.0 million shares were delivered upon settlement based upon the volume-weighted average price (VWAP) over the term of the agreement, less a discount. In total, 11.6 million shares were purchased through the $1.0 billion ASR.

We have approximately $2.8 billion remaining under the stock repurchase program as of December 31, 2022. No duration has been placed on the repurchase program. We reserve the right to discontinue the repurchase program at any time. Refer to Note 12. Stockholders' Equity for further information on stock repurchases.

As of December 31, 2022, we had an aggregate principal amount of $15.7 billion of senior notes issued and outstanding. The indentures governing our various maturities of senior notes contain limited restrictive covenants. As of December 31, 2022, we were in compliance with all covenants.

As part of our capital allocation strategy, we may decide to repurchase debt or raise capital through the issuance of debt in the form of senior notes. In 2022, the Company's Board of Directors also authorized a new $1.0 billion senior note debt repurchase program. During 2022, we repurchased $318 million of our par value senior notes for $300 million. As of December 31, 2022, there was $700 million available under the senior note debt repurchase program. Refer to Note 10. Debt for further information regarding the issuance and redemption of senior notes.

The credit agreement underlying our Revolving Credit Facility and Term Loan Facility contains customary covenants, as well as financial covenants, including, a minimum fixed charge coverage ratio and a maximum debt to EBITDA ratio. Our maximum debt to EBITDA ratio under the credit agreement may not exceed 4.0 to 1.0. As of December 31, 2022, we had $58 million of borrowings outstanding under our Revolving Credit Facility, $2.2 billion of borrowings outstanding under our Term Loan Facility, and we were in compliance with all covenants. As of December 31, 2022, there were no limitations on the availability of our Revolving Credit Facility as a result of the debt to EBITDA ratio.

In October 2017, we executed a $200 million non-recourse construction loan to fund the expansion of our corporate headquarters. In December 2022, we paid off the outstanding balance of the construction loan.

We had outstanding letters of credit of $217 million as of December 31, 2022, which were not part of our Revolving Credit Facility. The letters of credit bore weighted interest of 0.6% as of December 31, 2022. In addition, we had outstanding surety bonds of $1.3 billion as of December 31, 2022.

At December 31, 2022, our debt to capital ratio, defined as total debt divided by the sum of total debt and total equity, was 42.7%, compared to 41.2% at December 31, 2021. The debt to capital ratio increase was driven by stock repurchases in 2022. We utilize the debt to capital ratio as a measure, among others, of our leverage and financial flexibility.

At December 31, 2022, we had working capital, defined as current assets less current liabilities, of $1.7 billion, compared to $2.7 billion at December 31, 2021. Working capital was substantially reduced in January 2022 upon the closing of the Magellan acquisition for the purchase price payment and corresponding closing costs. We manage our short-term and long-term investments with the goal of ensuring that a sufficient portion is held in investments that are highly liquid and can be sold to fund short-term requirements as needed.

During the years ended December 31, 2022 and 2021, we received dividends of $1.6 billion and $2.5 billion, respectively, from our regulated subsidiaries.

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2023 Expectations

During 2023, we expect to receive net dividends of approximately $2.1 billion from our regulated subsidiaries and expect to spend approximately $845 million in capital expenditures primarily associated with system enhancements.

We have material debt, short-term medical claims, lease, and contingencies obligations. Refer to Note 10. Debt, Note 8. Medical Claims Liability, Note 11. Leases, and Note 18. Contingencies, respectively, for further information.

Based on our operating plan, we expect that our available cash, cash equivalents and investments, cash from our operations, and cash available under our Revolving Credit Facility will be sufficient to finance our general operations and capital expenditures for at least 12 months from the date of this filing. While we are currently in a strong liquidity position and believe we have adequate access to capital, we may elect to increase borrowings on our Revolving Credit Facility. In addition, from time to time we may elect to raise additional funds for these and other purposes, either through issuance of debt or equity, the sale of investment securities, or otherwise, as appropriate. In addition, we may strategically pursue refinancing or redemption opportunities to extend maturities and/or improve terms of our indebtedness if we believe such opportunities are favorable to us.

We intend to continue to evaluate strategic actions in connection with our Value Creation Plan, targeting initiatives to improve productivity, efficiencies, and reduced organizational costs, as well as capital deployment activities, including stock repurchases, portfolio optimization, and the evaluation of refinancing opportunities.

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REGULATORY CAPITAL AND DIVIDEND RESTRICTIONS

Our operations are conducted through our subsidiaries. As managed care organizations (MCOs), most of our subsidiaries are subject to state regulations and other requirements that, among other things, require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing, payment, and amount of dividends and other distributions that may be paid to us. Generally, the amount of dividend distributions that may be paid by a regulated subsidiary without prior approval by state regulatory authorities is limited based on the entity's level of statutory net income and statutory capital and surplus.

As of December 31, 2022, our subsidiaries had aggregate statutory capital and surplus of $16.4 billion, compared with the required minimum aggregate statutory capital and surplus requirements of $8.0 billion. During the year ended December 31, 2022, we received dividends of $1.6 billion from and made $729 million of capital contributions to our regulated subsidiaries. For our subsidiaries that file with the National Association of Insurance Commissioners (NAIC), we estimate our Risk Based Capital (RBC) percentage to be in excess of 350% of the Authorized Control Level.

Under the California Knox-Keene Health Care Service Plan Act of 1975, as amended (Knox-Keene), certain of our California subsidiaries must comply with tangible net equity (TNE) requirements. Under these Knox-Keene TNE requirements, actual net worth less unsecured receivables and intangible assets must be more than the greater of (i) a fixed minimum amount, (ii) a minimum amount based on premiums, or (iii) a minimum amount based on healthcare expenditures, excluding capitated amounts.

Under the New York State Department of Health Codes, Rules and Regulations Title 10, Part 98, our New York subsidiary must comply with contingent reserve requirements. Under these requirements, net worth based upon admitted assets must equal or exceed a minimum amount based on annual net premium income.

The NAIC has adopted rules which set minimum risk-based capital requirements for insurance companies, MCOs, and other entities bearing risk for healthcare coverage. As of December 31, 2022, each of our health plans was in compliance with the risk-based capital requirements enacted in those states.

As a result of the above requirements and other regulatory requirements, certain of our subsidiaries are subject to restrictions on their ability to make dividend payments, loans, or other transfers of cash to their parent companies. Such restrictions, unless amended or waived or unless regulatory approval is granted, limit the use of any cash generated by these subsidiaries to pay our obligations. The maximum amount of dividends that can be paid by our insurance company subsidiaries without prior approval of the applicable state insurance departments is subject to restrictions relating to statutory surplus, statutory income, and unassigned surplus. As of December 31, 2022, the amount of capital and surplus or net worth that was unavailable for the payment of dividends or return of capital to us was $8.0 billion in the aggregate.

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RECENT ACCOUNTING PRONOUNCEMENTS

For this information, refer to Note 2. Summary of Significant Accounting Policies, in the Notes to the Consolidated Financial Statements, included herein.

CRITICAL ACCOUNTING ESTIMATES

Our discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements which have been prepared in accordance with GAAP. Our significant accounting policies are more fully described in Note 2. Summary of Significant Accounting Policies, to our consolidated financial statements included elsewhere herein. Our accounting policies regarding intangible assets, medical claims liability, and revenue recognition are particularly important to the portrayal of our financial condition and results of operations and require the application of significant judgment by our management. As a result, they are subject to an inherent degree of uncertainty. We have reviewed these critical accounting policies and related disclosures with the Audit and Compliance Committee of our Board of Directors.

Goodwill and Intangible Assets

We have made several acquisitions that have resulted in our recording of intangible assets. These intangible assets primarily consist of purchased contract rights and customer relationships, provider contracts, trade names, developed technologies, and goodwill. Key assumptions used in the valuation of these intangible assets include, but are not limited to, member attrition rates, contract renewal probabilities, revenue growth rates, expectations of profitability, and discount and royalty rates. We allocate the fair value of purchase consideration to the assets acquired and liabilities assumed based on their fair values at the acquisition date. The excess of the fair value of consideration transferred over the fair value of the net assets acquired is recorded as goodwill. Goodwill is generally attributable to the value of the synergies between the combined companies and the value of the acquired assembled workforce, neither of which qualifies for recognition as an intangible asset. At December 31, 2022, we had $18.8 billion of goodwill and $6.9 billion of other intangible assets.

Intangible assets are amortized using the straight-line method over the following periods:

Our management evaluates whether events or circumstances have occurred that may affect the estimated useful life or the recoverability of the remaining balance of goodwill and other identifiable intangible assets. If the events or circumstances indicate that the remaining balance of the intangible asset or goodwill may be impaired, the potential impairment will be measured based upon the difference between the carrying amount of the intangible asset or goodwill and the fair value of such asset. Our management must make assumptions and estimates, such as the discount factor, future utility, and other internal and external factors, in determining the estimated fair values. While we believe these assumptions and estimates are appropriate, other assumptions and estimates could be applied and might produce significantly different results.

Goodwill is reviewed annually during the fourth quarter for impairment. In addition, an impairment analysis of intangible assets would be performed based on other factors. These factors include significant changes in membership, financial performance, state funding, medical contracts, and provider networks and contracts.

If a reporting unit's carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. We first assess qualitative factors to determine if a quantitative impairment test is necessary. We generally do not calculate the fair value of a reporting unit unless we determine, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. However, in certain circumstances, such as recent acquisitions, we may elect to perform a quantitative assessment without first assessing qualitative factors.

We do not believe any of our reporting units are currently at risk for impairment. However, as part of our Value Creation Plan, we are completing a portfolio review and may identify changes in strategic focus, which could result in future impairments of goodwill or intangibles based on market indicators at that time.

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Medical Claims Liability

Our medical claims liability includes claims reported but not yet paid, or inventory, estimates for claims incurred but not reported (IBNR), and estimates for the costs necessary to process unpaid claims at the end of each period. We estimate our medical claims liability using actuarial methods that are commonly used by health insurance actuaries and meet Actuarial Standards of Practice. These actuarial methods consider factors such as historical data for payment patterns, cost trends, product mix, seasonality, utilization of healthcare services, and other relevant factors.

Actuarial Standards of Practice generally require that the medical claims liability estimates be adequate to cover obligations under moderately adverse conditions. Moderately adverse conditions are situations in which the actual claims are expected to be higher than the otherwise estimated value of such claims at the time of estimate. The claims amounts ultimately settled will most likely be different than the estimate that satisfies the Actuarial Standards of Practice. We include in our IBNR an estimate for medical claims liability under moderately adverse conditions which represents the risk of adverse deviation of the estimates in our actuarial method of reserving.

We use our judgment to determine the assumptions to be used in the calculation of the required estimates. The assumptions we consider when estimating IBNR include, without limitation, claims receipt and payment experience (and variations in that experience), changes in membership, provider billing practices, healthcare service utilization trends, cost trends, product mix, seasonality, prior authorization of medical services, benefit changes, known outbreaks of disease or increased incidence of illness such as influenza, provider contract changes, changes to fee schedules, and the incidence of high dollar or catastrophic claims.

We apply various estimation methods depending on the claim type and the period for which claims are being estimated. For more recent periods, incurred non-inpatient claims are estimated based on historical per member per month claims experience adjusted for known factors. Incurred hospital inpatient claims are estimated based on known inpatient utilization data and prior claims experience adjusted for known factors. For older periods, we utilize an estimated completion factor based on our historical experience to develop IBNR estimates. The completion factor is an actuarial estimate of the percentage of claims that have been received or adjudicated as of the end of a reporting period relative to the estimate of the total ultimate incurred costs for that same period. When we commence operations in a new state or region, we have limited information with which to estimate our medical claims liability. See "Risk Factors - Failure to accurately estimate and price our medical expenses or effectively manage our medical costs or related administrative costs could have a material adverse effect on our results of operations, financial condition, and cash flows." These approaches are consistently applied to each period presented.

Our development of the medical claims liability estimate is a continuous process which we monitor and refine on a monthly basis as additional claims receipts and payment information becomes available. As more complete claims information becomes available, we adjust the amount of the estimates and include the changes in estimates in medical costs in the period in which the changes are identified. In every reporting period, our operating results include the effects of more completely developed medical claims liability estimates associated with previously reported periods. We consistently apply our reserving methodology from period to period. As additional information becomes known to us, we adjust our actuarial models accordingly to establish medical claims liability estimates.

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The paid and received completion factors, claims per member per month, and per diem cost trend factors are the most significant factors affecting the IBNR estimate. The following table illustrates the sensitivity of these factors and the estimated potential impact on our operating results caused by changes in these factors based on December 31, 2022 data:

While we believe our estimates are appropriate, it is possible future events could require us to make significant adjustments for revisions to these estimates. For example, a 1% increase or decrease in our estimated medical claims liability would have affected net earnings by $103 million for the year ended December 31, 2022, excluding the effect of any return of premium, risk corridor, or minimum MLR programs. The estimates are based on our historical experience, terms of existing contracts, our observance of trends in the industry, information provided by our providers, and information available from other outside sources.

The change in medical claims liability is summarized as follows (in millions):

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Medical claims are usually paid within a few months of the member receiving service from the physician or other healthcare provider. As a result, the liability generally is described as having a "short-tail," which causes less than 5% of our medical claims liability as of the end of any given year to be outstanding the following year. We believe that substantially all the development of the estimate of medical claims liability as of December 31, 2022 will be known by the end of 2023.

Changes in estimates of incurred claims for prior years are primarily attributable to reserving under moderately adverse conditions. Additionally, as a result of minimum HBR and other return of premium programs, approximately $198 million, $492 million, and $86 million of the "Incurred related to: Prior years" was recorded as a reduction to premium revenues in 2022, 2021, and 2020, respectively. Further, claims processing initiatives yielded increased claim payment recoveries and coordination of benefits related to prior year dates of service. Changes in medical utilization and cost trends and the effect of population health management initiatives may also contribute to changes in medical claim liability estimates. While we have evidence that population health management initiatives are effective on a case by case basis, these initiatives primarily focus on events and behaviors prior to the incurrence of the medical event and generation of a claim. Accordingly, any change in behavior, leveling of care, or coordination of treatment occurs prior to claim generation and as a result, the costs prior to the population health management initiative are not known by us. Additionally, certain population health management initiatives are focused on member and provider education with the intent of influencing behavior to appropriately align the medical services provided with the member's acuity. In these cases, determining whether the population health management initiative changed the behavior cannot be determined. Because of the complexity of our business, the number of states in which we operate, and the volume of claims that we process, we are unable to practically quantify the impact of these initiatives on our changes in estimates of IBNR.

The following are examples of population health management initiatives that may have contributed to the favorable development through lower medical utilization and cost trends:

•Appropriate leveling of care for neonatal intensive care unit hospital admissions, other inpatient hospital admissions, and observation admissions, in accordance with InterQual or other evidence-based criteria or clinical policy.

•Management of our pre-authorization list, monitoring for over utilized services, and stringent review of durable medical equipment and injectables.

•Emergency department programs designed to collaboratively work with hospitals and members to steer non-emergent care to a more appropriate and cost effective setting (through patient education, on-site alternative urgent care settings, etc.).

•Increased emphasis on care management and clinical rounding where nurse or social worker care managers assist selected high-risk members with the coordination of healthcare services in order to meet a patient's specific healthcare needs.

•Incorporation of disease management, which is a comprehensive, multidisciplinary, collaborative approach to chronic illnesses such as asthma.

•Prenatal and infant health programs.

Revenue Recognition

Our health plans generate revenues primarily from premiums received from the states in which we operate health plans, premiums received from our members and CMS for our Medicare product, and premiums from members of our commercial health plans. In addition to member premium payments, our Marketplace contracts also generate revenues from subsidies received from CMS. We generally receive a fixed premium per member per month pursuant to our contracts and recognize premium revenues during the period in which we are obligated to provide services to our members at the amount reasonably estimable. In some instances, our base premiums are subject to an adjustment, in the form of a risk score or risk adjustment, based on the acuity of our membership. Generally, the risk score or risk adjustment is determined by the state or CMS analyzing submissions of processed claims and medical record data to determine the acuity of our membership, often relative to the respective program's membership. We estimate the amount of risk score and risk adjustment based upon the processed claims and medical record data submitted and expected to be submitted to CMS and record revenues on a risk adjusted basis. Some contracts allow for additional premiums related to certain supplemental services provided such as maternity deliveries.

Our contracts with states may require us to maintain a minimum HBR or may require us to share cost-savings in excess of certain levels. In certain circumstances, including commercial plans, our plans may be required to return premium to the state or policyholders in the event costs are below established levels. We estimate the effect of these programs and recognize reductions in revenue in the current period. Other states may require us to meet certain performance and quality metrics in order to receive additional or full contractual revenue. For performance-based contracts, we do not recognize revenue subject to refund until data is sufficient to measure performance.

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Revenues are recorded based on membership and eligibility data provided by the states or CMS, which is adjusted on a monthly basis by the states or CMS for retroactive additions or deletions to membership data. These eligibility adjustments are estimated monthly and subsequent adjustments are made in the period known. We continuously review and update those estimates as new information becomes available. It is possible that new information could require us to make additional adjustments, which could be significant, to these estimates.

Our Medicare Advantage contracts are with CMS. CMS deploys a risk adjustment model which apportions premiums paid to all health plans according to health severity and certain demographic factors. The CMS risk adjustment model pays more for members whose medical history would indicate that they are expected to have higher medical costs. Under this risk adjustment methodology, CMS calculates the risk adjusted premium payment using diagnosis data from hospital inpatient, hospital outpatient, physician treatment settings as well as prescription drug events. We and the healthcare providers collect, compile and submit the necessary and available diagnosis data to CMS within prescribed deadlines. We estimate risk adjustment revenues based upon the diagnosis data submitted and expected to be submitted to CMS and record revenues on a risk adjusted basis.

For qualifying low-income prescription drug benefit members, CMS pays for some, or all, of the member's monthly premium. We receive certain Part D prospective subsidy payments from CMS for these members as a fixed monthly per member amount, based on the estimated costs of providing prescription drug benefits over the plan year, as reflected in our bids. Approximately nine to ten months subsequent to the end of the plan year, or later in the case of the coverage gap discount subsidy, a settlement payment is made between CMS and our plans based on the difference between the prospective payments and actual claims experience.

Our specialty services generate revenues under contracts with state and federal programs, healthcare organizations, and other commercial organizations, as well as from our own subsidiaries. Revenues are recognized when the related services are provided or as ratably earned over the covered period of services. For performance-based measures in our contracts, revenue is recognized as data sufficient to measure performance is available. We recognize revenue related to administrative services under the TRICARE government-sponsored Managed Care Support Contract for the DoD's TRICARE program on a straight-line basis over the option period, when the fees become fixed and determinable. The TRICARE contract includes various performance-based measures. For each of the measures, an estimate of the amount that has been earned is made at each interim date, and revenue is recognized accordingly.

Some states enact premium taxes, similar assessments, and provider pass-through payments, collectively premium taxes, and these taxes are recorded as a separate component of both revenues and operating expenses. Additionally, our insurance subsidiaries were previously subject to the ACA annual health insurer fee (HIF). Beginning in 2021, the HIF was permanently repealed. This revenue was recorded as premium tax and health insurer fee revenue in the Consolidated Statements of Operations. For certain products, premium taxes, state assessments, and the HIF are not pass-through payments and are recorded as premium revenue and premium tax expense or health insurer fee expense in the Consolidated Statements of Operations.

Some states require state directed payments that have minimal risk, but are administered as a premium adjustment. These payments are recorded as premium revenue and medical costs at close to a 100% HBR. In many instances, we have little visibility to the timing of these payments until they are paid by the state.

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