Earnings Call Transcript - ELV Q2 2025

Nathan Allen Rich, Vice President of Investor Relations

Good morning, and welcome to Elevance Health's Second Quarter 2025 Earnings Conference Call. My name is Nathan Rich, Vice President of Investor Relations. With us this morning on the earnings call are Gail Boudreaux, CEO, Mark Kaye, our CFO; Pete Haytaian, President of Carillon; Morgan Kendrick, President of our Commercial Health Benefits business; and Felicia Norwood, President of our Government Health Benefits business. Gail will begin the call with a discussion of our second quarter performance and revised outlook as well as the progress we've made against our strategic initiatives. Mark will then discuss our financial results and outlook in greater detail. After our prepared remarks, the team will be available for Q&A. During the call, we will reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are available on our website, elevancehealth.com. We will also be making forward-looking statements on this call. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of Elevance Health. These risks and uncertainties may cause actual results to differ materially from our current expectations. We advise listeners to carefully review the risk factors discussed in today's press release and in our quarterly filings with the SEC. I will now turn the call over to Gail.

Gail Koziara Boudreaux, CEO

Good morning, and thank you for joining us. Let me start by directly addressing our revised full year outlook. We know this adjustment is disappointing, and we're taking concrete actions to address it. Our focus is on execution, making the right decisions now to strengthen the business and position Elevance Health for long-term sustainable performance. Our strategy remains grounded in delivering whole health solutions that are simple, affordable, and personalized. While the external environment continues to evolve, we are focused on the areas within our control: managing cost, deploying targeted investments, and reinforcing the operational foundation that supports long-term value creation. In the second quarter, we delivered adjusted EPS consistent with our expectations. These results reflect continued strength in our Medicare Advantage portfolio and disciplined cost management across key parts of the business as we navigate evolving dynamics in the ACA and Medicaid markets. Our Carillon platform continues to drive growth. Carelon Rx is gaining traction in the market with its integrated medical pharmacy offering, and Carelon Services delivered strong results with CareBridge scaling rapidly across dual eligible and high-acuity Medicaid populations. As I mentioned at the start of the call, we are revising our full year 2025 adjusted EPS guidance to approximately $30. This reset reflects the same pressures that others in the sector have now confirmed, particularly elevated medical cost trends across ACA and slower-than-expected Medicaid rate alignment. Importantly, this decision is anchored in our view that the elevated trends we are now observing will persist and reflects our updated visibility into the second half of the year. It is not based on assumptions of a near-term recovery. We are choosing to act now, not later, to ensure our outlook reflects prevailing conditions and to give investors clear visibility. We believe this step positions us to execute with discipline and begin rebuilding long-term margin stability that will empower our future growth. Looking ahead, we're executing against a clear strategy focused on strengthening structural performance across the enterprise. We're advancing our efforts to stabilize trends, particularly in high-cost areas like specialty services, post-acute care, and certain outpatient settings. Our programs focused on ensuring the right care in the right setting grounded in safety, quality, and outcomes. In support of our commitment to simplify care delivery, we've significantly streamlined our prior authorization processes, with over half of electronic requests now processed in real time and fewer requirements for high-performing providers. Our AI-enabled tools, such as Health OS and intelligent clinical assist, help streamline clinical workflows and accelerate routine approvals by surfacing relevant data. All medical decisions requiring clinical judgments are reviewed by licensed professionals with independent oversight to ensure care is appropriate, consistent, and aligned with our commitment to quality. We're also using advanced analytics to identify fraud, waste, and abuse, enabling us to intervene where patterns deviate from clinical and billing standards, reinforcing system integrity while protecting appropriate access to care. Our value-based care portfolio continues to expand, particularly in behavioral health and oncology. More than one-third of our benefit expense is now in downside risk arrangements, supporting improved care coordination and cost predictability. Through Carelon, we're scaling these capabilities across Elevance Health and with external clients, helping to drive better outcomes for complex and chronic populations. Importantly, these are not future state aspirations; they are embedded in our operations today and form the core of our multiyear plan to stabilize margins and build sustainable earnings power. While it is still early to provide an initial outlook for 2026, the actions we're taking are designed to stabilize trends, improve pricing alignment, and restore operating leverage over time. In ACA, we've already repriced products for rising cost intensity. We also expect a broader market reset in 2026 as the scheduled expiration of enhanced subsidies drives further risk pool changes, and our position reflects early disciplined action. In Medicaid, we're proactively engaged with state partners to ensure that upcoming rate cycles continue to reflect the developing acuity environment. While rate recovery has lagged current cost levels, we expect a meaningful catch-up as utilization data becomes more actionable. In commercial, we're maintaining a disciplined approach to pricing, ensuring our renewals and network contracts are aligned to the trend environment. And in Medicare Advantage, we bid with discipline with a focus on margin normalization supported by stable utilization and Carelon-led clinical programs. These steps combined with our structural cost levers and care management, payment integrity, and value-based care delivery are designed to improve visibility and consistency as we move through 2025 and into the next phase of growth. We recognize that revising guidance for the second consecutive year is disappointing, and we remain committed to transparency and strong execution as we continue to navigate unprecedented cost trends affecting multiple lines of business. We're taking this step to reflect what we can control, sharpening our execution, focusing our investments, and strengthening the core drivers that will support a more durable and sustainable future. This would not be possible without the dedication of our nearly 100,000 associates that amplify our impact every day. We remain confident in the strength of our enterprise, the impact of our investments, and our ability to create long-term value through operational discipline, innovation, and our commitment to whole health transformation. With that, I'll turn it over to Mark to walk through the financials. Mark?

Mark Bradley Kaye, CFO

Thank you, and good morning, everyone. Elevance Health reported second quarter GAAP diluted earnings per share of $7.72 and adjusted diluted earnings per share of $8.84. As Gail discussed, we have updated our full-year 2025 adjusted earnings per share to be approximately $30, reflecting both an industry-wide increase in morbidity impacting our ACA business and a slower deceleration in Medicaid cost trend, pressures we expect to continue in the second half. Although external conditions remain dynamic, we are prioritizing factors we can directly influence and which are within our control, including taking decisive actions to stabilize trends and align pricing for long-term sustainability. We ended the second quarter with 45.6 million medical members, down approximately 200,000 sequentially, driven by a reduction in Medicaid membership and lower effectuation rates in our ACA business, a dynamic we first highlighted on last quarter's earnings call. Operating revenue was $49.4 billion, an increase of 14% year-over-year, principally reflecting higher premium yields in recognition of elevated cost trends and recently completed acquisitions in home health and specialty pharmacy. The consolidated benefit expense ratio was 88.9%, an increase of 260 basis points year-over-year, driven by our ACA and Medicaid businesses, partially offset by a favorable out-of-period settlement with a value-based care provider. In the ACA market, membership shifts from Medicaid into ACA following the redetermination process, together with lower effectuation rates, have driven a market-wide increase in morbidity resulting in elevated medical cost trends. We have also reviewed the latest data from the Wakely Consulting Group, and our expectation for risk adjustment remains unchanged. Importantly, our 2026 rate filings capture both the current increase in market-wide morbidity and further risk pool deterioration resulting from the anticipated expiration of the enhanced subsidies. Medicaid cost trend decelerated in the second quarter, though at a more modest pace than initially expected. We are experiencing higher acuity resulting from ongoing disenrollment as well as an overall increase in member utilization. The rate updates we received for the July cohort aligned with our initial assumption that lagged current trend levels. As a result, we now anticipate a prolonged Medicaid margin recovery period as it will take time for states to incorporate the latest experience into rates. Medicare Advantage cost trends remain in line with our expectations, with Part D seasonality progressing as anticipated, and we continue to target stable margins for the year. Our adjusted operating expense ratio of 10.0% improved 140 basis points year-over-year. We are prioritizing strategic investments in innovative care models, artificial intelligence, and pharmacy services to support long-term success. Carelon's strong performance in the second quarter underscores our steadfast commitment to expanding its capabilities as we power our enterprise flywheel for growth. Carelon Rx grew operating revenue by over 20% as we gained traction with larger clients and scaled our specialty pharmacy assets. Profitability in the quarter was impacted by ongoing initiatives around accelerating growth as we expand upmarket. Carelon Services delivered greater than 50% growth in revenue and operating gain through its expansion of risk-based relationships and the integration of CareBridge. Turning to the balance sheet. We ended the quarter with a debt-to-capital ratio of 40.8%, preserving flexibility for strategic investments and opportunistic capital deployment. Year-to-date, we've returned approximately $2 billion to investors. Operating cash flow totaled $2.1 billion in the quarter, and we now expect approximately $6 billion for the full year reflecting our revised earnings outlook and discrete working capital items. Turning to our revised guidance for 2025. We forecast our benefit expense ratio to be approximately 90% for the full year as elevated trend levels persist in our ACA and Medicaid businesses. In a dynamic operating environment, this outlook is a prudent foundation for execution during the second half of the year. With respect to seasonality, we contemplate slightly more earnings to be realized in the third quarter relative to the fourth quarter. And looking ahead, we're also assessing the implications of the recently passed budget reconciliation bill, particularly Medicaid work requirements and more frequent eligibility reviews, as well as the scheduled expiration of the enhanced marketplace subsidies. These changes could present near-term enrollment pressures and further shifts in the risk pool. Finally, we are focused on restoring margin stability and building long-term earnings power through disciplined pricing, growth in Carelon, and investments in technology to deliver value for our members and shareholders over time. With that operator, please open the lines for questions.

Operator, Operator

For our first question, we'll go to the line of Andrew Mok from Barclays.

Andrew Mok, Analyst

Question on the ACA. Can you help delineate the pressure you're seeing in that business between unit cost trends and shifts in the risk pool? And in the prepared remarks, I think you said your expectation for risk adjustment this year remains unchanged for the current year. So can you explain how that's possible given the higher morbidity that we're seeing?

Mark Bradley Kaye, CFO

Andrew, thank you for your question. There are three main factors we are observing that contribute to the significant increase in medical trends in our ACA business. First, the risk pool's acuity and morbidity have significantly increased due to a higher ratio of healthier members, particularly in states with a larger number of fully subsidized individuals. This change has been driven by market exits and the movement of higher acuity members from Medicaid to ACA during the redetermination process, which accounts for approximately 70% of the total impact. The second and third factors relate to utilization, which is currently higher in various cost categories within the ACA, especially in emergency room visits, behavioral health services, and some specialty pharmacy prescription drugs, consistent with previously observed claims patterns. We are also noticing some providers using more aggressive coding strategies and inappropriately exploiting the independent dispute resolution process, leading to inflated costs for the entire healthcare system without improving patient care, which represents about 30% of the total impact. Regarding risk adjustment, it's important to note that the increase in member acuity we are seeing is due to a broader market-wide morbidity trend, not due to changes in our membership mix or risk adjustment profile.

Operator, Operator

Next, we'll go to the line of A.J. Rice from UBS.

Albert J. William Rice, Analyst

Thanks, everybody. I might just ask you, if possible, when we think about the revision you're making here, obviously, you're calling out the two areas, the public exchanges, the ACA marketplace and Medicaid. Can you size a little bit for us? Or give us a sense about how much the relative impact of each of those is in the guidance revision? And I would guess on Medicaid, it sounds like it's a matter of just pushing out 6 to 12 months having the data to get the updated rates? Is that the way to think about it? And then on the public exchanges, though, it sounds like you've got to reprice that you've got to take into account everything you're seeing this year plus the loss of the enhanced subsidies next year potentially. How challenging is that, if possible, to comment on at this point? And is margin recovery on the exchanges next year even practical to think about?

Gail Koziara Boudreaux, CEO

Thank you for your question, A.J. There are several components to consider. Let me take a moment to reframe our outlook. Firstly, as mentioned in our prepared remarks, we have adopted a cautious perspective for the full year, particularly reflecting the elevated trends we observed in the second quarter. Importantly, we are not relying on new initiatives to change the current trends or cost dynamics. Therefore, we are not anticipating any improvements in trends for the rest of the year. Regarding the Affordable Care Act, we have incorporated a higher morbidity profile into our forecast. We believe that morbidity has stabilized based on our observations, but we are also allowing for the possibility of greater utilization towards the end of the year, assuming there are no changes to the subsidies, as we expect more people will seek services before their coverage might lapse. This is a crucial assumption. For Medicaid, we are also planning for higher morbidity due to ongoing enrollment losses, which we saw in the second quarter in some states that have initiated more aggressive redetermination processes. We are observing these trends and anticipate a gradual alignment with rates. We have had constructive discussions, and the rates have aligned with our initial expectations. What has changed is that morbidity has increased due to these enrollment losses. However, the discussions about rates in our states remain positive. Again, we are not forecasting anything new in that area. We have made headway and expect a step down in the future. As Mark mentioned, we are actively working to address the cost trend. However, in terms of our forward guidance, we have not included that yet, but we recognize it is important. I'll now hand it over to Mark to address your question regarding the percentage issue and its implications.

Mark Bradley Kaye, CFO

Yes, very briefly, A.J., if you think about the reduction in full year guidance, split between ACA and Medicaid is slightly more weighted towards ACA.

Operator, Operator

Next, we'll go to the line of Stephen Baxter from Wells Fargo.

Stephen C. Baxter, Analyst

Just wanted to ask on the Medicaid side. I think the concern is kind of broadly that you're going to continue to get caught up on, I guess, what I would refer to as base period rates being incorrectly set, but then there's going to be a disconnect or potentially at risk of being a disconnect on forward trend where you're going to be continually underpaid there. I guess how do you think about that dynamic? Do you think that's an accurate characterization of really kind of what's happening right now? And how do you think you address that with states if you need to make some argument for higher forward trend than you perceived over the past couple of years?

Gail Koziara Boudreaux, CEO

Yes. Thanks for the question, Stephen. Just a couple of thoughts. I think first, we're going through what I would call an unusual cycle coming out of the pandemic where there was significant redetermination, the acuity changed pretty dramatically, and we have asked the states to move forward their view from their normal practices, and they've been very constructive. So again, I just want to reinforce that the discussions with the states based on the data that we've been sharing with them, they've been very responsive, and those rates have aligned when we look at our rating. We're seeing, again, though, some additional just because of moving forward of some of the new regulations that are coming in, additional redeterminations. And so that data needs to catch up with the states. Our sense is that will normalize over a couple of rate cycles. And again, they're using actually sound data. We're getting it in front of them faster than they've ever used it, and I think that's a very positive sign. Maybe I'll ask Mark if he wants to comment a little bit more specifically on the discussion with the states.

Mark Bradley Kaye, CFO

And very briefly, I'd add on here. So the updated guidance that we put out this year does anticipate slower trend deceleration together with that ongoing risk pool pressure to persist in the second half. Importantly here, Medicaid margins are still expected to show year-over-year improvement in the back half. We do expect them to remain positive for the full year, albeit below our long-term targets.

Operator, Operator

Next, we'll go to Lisa Gill from JPMorgan.

Lisa Christine Gill, Analyst

Can you talk about what you're observing in Medicare Advantage? Gail, you mentioned having Medicare Advantage in the quarter, and I'm curious about the trends you're seeing there. You also commented on your bids for 2026 regarding margin recovery, so could you provide more details on your outlook for bids related to Medicare Advantage?

Gail Koziara Boudreaux, CEO

Sure, thanks for the question, Lisa. Let me directly address your question regarding the trend in Medicare Advantage. It remained elevated and aligned with our expectations. This is consistent with what we've shared in the first quarter and at other conferences; we didn't observe any differences. I will let Felicia discuss our bid strategy and how we are approaching that.

Felicia Farr Norwood, President of Government Health Benefits

Lisa, thank you for the question. As we look ahead to 2026, it is still too early to be specific about our bid. But I will say that we continued a very disciplined and thoughtful approach in terms of how we approach the bid knowing that there is going to be the potential for some volatility as we head into 2026. We prioritized the plan offerings that we believe are going to deliver strong retention for us and sustainable long-term value for our members. We specifically focused on geographies and plan types that we've been very much focused on as we go forward, namely our HMO, our duals, and certainly looking to lean into margin as we think about 2026. So it's too early to comment on the more specifics of that, but we feel very good about how we are positioned, the actions we've taken to lean into margins as we go forward and the progress we continue to make around stabilizing and improving our margins in the MA program.

Gail Koziara Boudreaux, CEO

Thank you, Felicia. And the only add I would make is just a reminder, this has been a multiyear strategy for us over the last several bid cycles where we're really focused on trying to get to stability in this marketplace and have taken those approaches.

Operator, Operator

Next, we'll go to the line of Lance Wilkes from Bernstein.

Lance Arthur Wilkes, Analyst

Could you provide some insights on the utilization trends you are observing, while taking into account the risk pool deterioration in certain areas? It would be helpful to hear about utilization by category, such as inpatient and outpatient services, as well as any variations by segment. Additionally, please comment on the development of prior periods and how reserves are progressing.

Mark Bradley Kaye, CFO

Thanks very much for the question here. Maybe let me start off by saying the ACA marketplace is in the midst of a broad recalibration that is exerting near-term pressure on managed care performance across the industry. And there are several underlying drivers, some of which I called out a moment ago, but principally among them the migration of membership for Medicaid post-redeterminations onto the exchanges. And that, together with the lower effectuation rates we're seeing in some states, has made the resulting risk pool much more acute, and that's really what's driving the elevated medical cost trends. So in effect, again, you could think about this as a market-wide morbidity shift, not in Elevance's specific pricing or risk adjustment issue. As we think about the individual categories, as I noted earlier, chief among them is emergency room and behavioral health services. Maybe just to call out one stat here. For the ACA, we are seeing members in our 2024 and '25 cohort utilizing the emergency room at nearly twice the level of our commercial group members. And then finally, on prior year or prior period development, there's nothing of particular note to call out here. As you'll recall or as you'll see in our filed earnings release this morning was approximately $40 million for the quarter.

Operator, Operator

Next, we'll go to Justin Lake from Wolfe Research.

Justin Lake, Analyst

Just a couple of numbers questions here. First, I appreciate your color on the split of the guidance revision. If I think about the impact here, would it be fair to say your Medicaid margins are now maybe in the 1% range? And maybe the exchanges are slightly negative. And then just given the potential for margin improvement in Medicare, the exchanges, and Medicaid next year, do you see the potential to grow above the 12% LRP next year? And maybe you could share your view of headwinds and tailwinds in 2026.

Mark Bradley Kaye, CFO

Thank you for your question. There are a few parts to address. To begin, we don’t disclose specific margins for individual operations, but we anticipate that our operating margin for the ACA business will decrease year-over-year by a high single-digit percentage. This expectation highlights our proactive approach to disciplined pricing for 2026, our intensified management initiatives currently underway, and our assessment of selective provider contracts to rebuild margins and ensure long-term sustainability. Regarding Medicaid, we expect to see year-over-year improvement in margins in the latter half of the year. While they will remain positive for the full year, they will be below our long-term guidance.

Gail Koziara Boudreaux, CEO

Yes, thanks, Mark. Justin, in response to your second question, we are not in a position to provide formal guidance, but I can highlight some key areas. There are several variables to consider. First and foremost, we are maintaining significant discipline in our pricing due to cost trends. This applies to the ACA, where we are addressing higher market acuity and the possibility of further deterioration in the risk pool if subsidies are not renewed. In Medicaid, we are working with other states to ensure our rates align with member acuity and preparing for potential policy changes. In Medicare Advantage, as Felicia mentioned, we have implemented disciplined benefit designs and are focused on sustainable positioning and margin recovery. Additionally, we anticipate strong continued growth and performance from our Carelon business, as noted on today's call, and are seeing promising developments in our pipelines. The main uncertainty for us currently is the policy issues regarding the future of enhanced subsidies in the individual ACA market, particularly whether they will expire or be reduced, which is a crucial factor moving forward. We also anticipate the impact of the market integrity rule, which we believe will positively influence market discipline, although we need to fully understand its implications. Therefore, it’s too early for us to define our outlook. As I mentioned earlier, while these aspects remain uncertain, we are taking proactive measures even though we haven't incorporated them into the 2025 reforecast. We are dedicated to addressing the trends Mark discussed, including some troubling billing practices, as well as areas where we can make a difference, such as emergency room utilization. We will provide more clarity as the year unfolds, but I wanted to share our perspective on both the opportunities we recognize and the challenges we face as we navigate this year.

Operator, Operator

Next, we'll go to the line of Erin Wright from Morgan Stanley.

Erin Elizabeth Wilson Wright, Analyst

Great. More along those lines about some of the areas that are under your control. I guess more specifically, what are you doing maybe differently in terms of cost structure initiatives throughout the balance of the year and into next year? And can you speak to the major timing magnitude of those and how you're thinking about that as you approach some of those items that are more under your control?

Gail Koziara Boudreaux, CEO

Yes. Thanks very much, Erin. I mean I think there's a number of things that are within our control. Obviously, we have been managing our cost structure. Most with really, quite frankly, this was something we committed to at the beginning of the year, but the transformation of using technology fundamentally to simplify our processes, to automate our processes. That is ongoing, and we have shown, I think, very strong discipline, and that will continue, and that will drive run rate for us. We're also using our data and using AI, quite frankly, to get ahead of the cost curve. And what I mean by that is really trying to shift left to understand what's happening earlier in the process and making sure that we are identifying these trends, particularly these billing abnormalities that we're seeing, 1 great example of that is the IDI process, which Mark spoke about. This quarter, we took very aggressive action and filed a legal suit against what we think is the misuse of the IDR process under the No Surprises Act. And just to put that in perspective, we've seen out-of-network providers and their billing partners submit thousands of disputes sometimes hundreds in a single day, and our payment request can be significantly inflated, which is costing the entire health care system. Sometimes those are from as much as 21 times bill charges, just to give some perspective on this. We fully support that act, but we also know that it has to be implemented appropriately. So that's one example. We're also leaning into the work that Carelon has done. We had very good results in Carelon. So you think about the areas that Mark talked about our ability to take more of that and manage it through Carelon. I think is really important, whether it's around specialty services, areas like that. So again, we haven't embedded that in the trend right now, but we are clearly working on oncology, severe mental illness, MSK products, things of that nature that we think are important for affordability over the long haul. But again, take time to implement, and we know that the issues specifically in the individual ACA market are because the entire market has exhibited this increase in acuity across the board. So thank you very much for the question.

Operator, Operator

Next, we'll go to the line of Ben Hendrix from RBC Capital Markets.

Benjamin Hendrix, Analyst

Great. Just wondering if the current environment is making any or driving any drastic changes to your capital allocation strategy this year. Are you still thinking about the kind of 50-50 split of investment versus return on capital? And then to the extent that the M&A and organic reinvestment piece of it is changing, are there shifts there that may allocate more capital internally versus for example adding capabilities to Carelon or other activities? Just any thoughts on capital allocation for the rest of the year?

Mark Bradley Kaye, CFO

Ben, thanks very much for the question. In the second quarter, we repurchased approximately $380 million worth of shares. But importantly here, our adjusted share repurchase pacing in the second quarter was different, and it was different because we wanted to ensure we had enough flexibility heading into what we see as a dynamic rate and margin environment. That said, in my opinion, with the stock trading well below what we see as its intrinsic value, I really wanted to make sure that we retain full flexibility to be more opportunistic in the periods ahead. We are firmly on track to achieve our full-year diluted weighted average share count of 225 million to 226 million. But the idea is we want to be opportunistic. More broadly on M&A, our focus in 2025 is really on integration and scaling of the acquisitions that we completed last year. So we do anticipate lower levels of M&A activity this year, with a greater emphasis, as I mentioned a minute ago, on opportunistic share repurchases. And then as I try to think over the long term, we're going to maintain consistency with our algorithm, meaning we'll target deploying about 50% of free cash flow towards M&A, organic reinvestment back into the business, with the other 50% being returned to shareholders, including 30% for share repurchases and about 20% for dividends.

Operator, Operator

Next, we'll go to the line of Joshua Raskin from Nephron Research.

Joshua Richard Raskin, Analyst

I guess my question is really about your commentary around creating more stability and predictability, and maybe what could be done differently in the future. We've spoken about the potential for risk pool changes, both in the ACA exchanges and on the Medicaid side. And so how do you change that pricing process for the ACA or rate negotiations with the state? What makes this business more predictable in the future?

Mark Bradley Kaye, CFO

Thanks very much for the question, Josh. Let me maybe step back for a moment. We continue to see the ACA market as a valuable and a complementary business to our Carelon and Medicaid segment. And that's because it enables us to extend affordable coverage to more consumers while maintaining balanced profitable growth. We very much appreciate CMS' ongoing efforts to promote stability in the individual market and get that gets at the heart of your question. They included several provisions in the recently finalized marketplace integrity and affordability rule that supported that goal, including, for example, the elimination of the monthly special enrollment periods. They strengthened pre-enrollment verification of income. And I think all of that contributes. And importantly, I'd add, our rate filings that are upcoming for the '26 cycle will capture both the current acuity and our expectation for further deterioration in the risk pool in 2026. And so in my opinion, and our team as management, more obviously could be done here. Ultimately, we believe the ACA market will likely be smaller and higher acuity driven next year, especially if the enhanced subsidies expire. And one other quick comment just on Medicaid from an earlier question. We do expect the full year 2025 Medicaid cost trend to be driven approximately one-third from acuity and about two-thirds from utilization and coding.

Operator, Operator

Next, we'll go to the line of Dave Windley from Jefferies.

David Howard Windley, Analyst

I wanted to confirm an understanding and then pose a question. So Mark, to your earlier answer on ACA, if I understand right on risk adjustment, you're basically saying the pool is deteriorating; your book is basically shifting in line with the broader risk pool. So your risk adjustment assumptions don't change; your risk transfer assumptions don't change from your beginning of your expectations? Is that the right understanding of what you're saying? And therefore, the pressure on your book is reflective of just the deterioration of the book. Is that right?

Mark Bradley Kaye, CFO

Dave, that is spot on. And I would go one step further to say you could think about the acuity in the ACA market at this point in time, largely being stabilized post those lower effectuation rates the industry saw in April.

Operator, Operator

Next, we'll go to the line of Ryan Langston from TD Cowen.

Ryan M. Langston, Analyst

Mark, I hope I heard you right, but I think you said Medicaid cost trend decelerated into the second quarter slightly, but underlying utilization increased. I guess if I have that right, do you really have a sense on what's actually driving that utilization pick up? And we've seen some commentary by other competitors of states carving in benefits without suitable rate increases. Are you seeing that in your states?

Mark Bradley Kaye, CFO

Medicaid cost trends did moderate in the second quarter. The slowdown was less significant than we had anticipated. To elaborate on Gail's earlier point, we are experiencing more disenrollments among lower acuity members, particularly as states implement stricter eligibility reviews. This naturally increases the average acuity of the remaining population. Regarding elevated utilization, the key areas include long-term services and supports, behavioral health, and inpatient medical surgery care. These factors are contributing to rising costs and explain why the deterioration in trends is occurring more slowly than we expected. The split for acuity and utilization currently stands at one-third for acuity and two-thirds for utilization. I recognize this differs from 2024, where we projected a 60% impact from acuity and 40% from utilization, mainly because the effects of redetermination-related acuity have largely been absorbed, while we are still seeing high levels of utilization.

Gail Koziara Boudreaux, CEO

Yes. Regarding your question about the carv-ins, the standard procedure for states rolling out new programs typically involves collaborating with their actuaries to determine the appropriate amount. If there happens to be a discrepancy, we continue to engage with them, and they are generally very responsive. Therefore, I would not view this as a major factor for us; rather, it's primarily a timing issue, and we expect to get it right as they gain more experience with the program.

Operator, Operator

Next, we'll go to the line of Sarah James from Cantor Fitzgerald.

Sarah Elizabeth James, Analyst

Can you talk about how Carelon margins are lining up compared to your initial expectations? And then some of the growth-related pressure on the Rx side from growth in large employers and specialty and then on services from CareBridge. When do you expect that to normalize? Or is the shift in Carelon Rx more of a long-term margin shift with the new mix?

Peter David Haytaian, President of Carillon

Thanks for the question. Sarah, you asked a lot there about Carelon, so I'll try to cover it all. On the services side, again, really strong growth, as we've talked about, and that's contributed to the year-over-year performance improvement. And as it relates to margins and service as you specifically asked about, they came in within our expectations, slightly down from last year. Again, that was largely driven by CareBridge, as well as continued expansion of risk arrangements and taking on more risk both in Elevance Health and externally. We're also very happy about what we're seeing externally in terms of growth. And so that is all contributing to our performance. In terms of how that progresses through the year, I think that that's what you were asking as well. Similarly, because of seasonality in these risk deals, we'll see that margin decrease throughout the year. And again, with the addition of CareBridge, our margin moderates because it comes with a different profile from a margin perspective. On the Rx side, similarly, very strong growth. In fact, it was our strongest year of growth yet. And that actually is contributing to the issues associated with our margin. The year-over-year performance from an operating perspective actually improved in pharmacy pretty nicely, 7.8% in the quarter. Margins were lower because of the very significant growth that we're seeing. We continue to do well down market and middle market, but also we're seeing an expansion at the upper end of the market with some large jumbo accounts. And so we’re investing in that pretty heavily as it relates to both this year and going into next year. And I would largely put that in the context of a lot of the differentiated services that we're working on along with our commercial business, programs like Total Health Connect that is really oriented to whole health and differentiated customer service. So we look forward to that continued growth and expansion in our pharmacy business.

Operator, Operator

Next, we'll go to the line of George Hill from Deutsche Bank.

George Robert Hill, Analyst

Yes. Mark, except for the Q4 surge in acuity in the ACA business, it seems like you called out. I guess first, I would ask, can you kind of quantify the expectation there? And are there any other one-time items or things that you would call out in the guide as it relates to the back of the year assumptions, given that the deterioration kind of in the earnings power looks pretty significant in the back half of the year?

Mark Bradley Kaye, CFO

Thanks very much for the question. Maybe what I'll take this is to talk a little bit about seasonality between the third and fourth quarter. We do anticipate a modestly higher portion of earnings to be realized in the third quarter compared to the fourth quarter. And while our fourth-quarter outlook reflects some utilization pull forward in the ACA exchange business, as you mentioned, I'd say there's also evolving seasonality dynamics that we've called out previously in Part D offering. The expected step down in earnings is lower than what one normally would expect. And there are two factors here. First, in fact, most importantly, we expect a discrete non-operating tax benefit to be recognized at year-end. And then second, to a lesser extent, the savings from the incremental expense reduction efforts, our in-flight medical cost management programs are going to have the greatest impact in Q4 helping to offset that higher trend that we've modeled into our business. And so taken together, those two factors would account for what we're seeing and likely what you're asking about.

Operator, Operator

Next, we'll go to the line of Jason Cassorla from Guggenheim.

Jason Paul Cassorla, Analyst

Great. Just on Medicaid, I guess, given the continued disconnect there, I mean, you've talked about this being a near-term issue, wanting to be a continued partner to states, but your comments before around the potential for normalization, rate cycle normalization over the next couple of rate cycles. Are you coming to a point where it could make sense to potentially exit states or reduce footprints within certain populations? Or maybe what would you have to see outright to start considering those possibilities, I guess, in context if you're trying to improve margins for that business?

Gail Koziara Boudreaux, CEO

Yes. Thanks for the question. I think there's a couple of things. One, states in our footprint have been very responsive in terms of the alignment of what we've shown them. And we do believe at this stage it is really catching the data up once we have the data in front of them. They have been again improving the rates to align with the acuity of the population. So I think that question is clearly, we're always looking at ensuring that we have a stable Medicaid population that is aligned to the acuity, and we get appropriate rates. And I think it's premature from what we've seen from our states to make those kind of determinations because, again, it's been very productive, and our states have been very responsive. Although again, it's a lag because what they're facing as well. So again, but we are always looking at this, and thank you very much for the question.

Operator, Operator

Next, we'll go to the line of Whit Mayo from SVB Leerink.

Benjamin Whitman Mayo, Analyst

Just a quick one. Maybe just an update on where you think you are around commercial margins now in light of all the commentary and how you're thinking about the pace of getting back to the targets? And any comments maybe on midyear renewals for your fully insured business.

Mark Bradley Kaye, CFO

Whit, thank you very much for the question. I'd start by saying that we continue to be very pleased with the trajectory of our large group commercial margin recovery over the past couple of years. In 2025, our guidance continues to include expected strong consistent margin performance. On utilization in that group just because we haven't touched on it, I'd say group medical trend continues to remain elevated, but really importantly, in line with what we've expected and what we priced for. Similar cost pressures in that market: emergency room visits, physician-delivered BH services, and specialty pharmacy. If I think overall commercial margins, we obviously expect a slight decline this year. That just reflects the performance of our ACA business, which we've spoken about.

Gail Koziara Boudreaux, CEO

Thanks, Mark, and maybe I'll ask Morgan Kendrick just to talk a little bit about what he's seeing in the market. I think that's an important context.

Morgan Kendrick, President of Commercial Health Benefits

Thank you for the question. As Mark mentioned, aside from the ACA, we are quite satisfied with the overall performance of the business. You referred to the large group fully insured or risk business in your question, and I believe we are seeing the market strengthen significantly in terms of pricing. A few years ago, there was a surge in membership, but now the market has adjusted to appropriate trends and pricing. After the second largest cohort in July, we feel confident about how our retention has turned out. Where there is potential, we continue to successfully sell large group fully insured products across our regions, although many entities with some risk tolerance are looking to shift to self-funded options. This is where we notice the losses on the risk side; they generally move towards self-funding with us. Overall, we are pleased with the business, which aligns with our perception of the national business performance, showing strong results.

Gail Koziara Boudreaux, CEO

Thank you, Morgan. And I think the theme there, just to sort of call it out, is we've seen, I think, a much more rational hardening market in our fully insured products across the board, and Morgan and the team have done a nice job there. We have time, I think, for one more question.

Operator, Operator

And for our final question, we'll go to the line of Michael Hall from Baird.

Michael Hall, Analyst

Quick one first on exchanges. I understand the FTR rechecks this year had been delayed to the summer. Is that already concluded? Has that member attrition been reflected in your updated guide? Just trying to understand if that could be another issue to drop? And then my main question, I guess, the piggyback off of Kevin, and Stephen's question, but maybe to frame it slightly differently. As we look ahead and as it relates to work requirements, as we think about Georgia, Arkansas precedents, what we just experienced with redeterminations, the large disenrollment from procedural reasons. And now with the new timeline starting '27, all the preparation states need, especially with what you mentioned with how they've struggled with all the volume of processes. How do you gain comfort that work requirements won't catalyze another big procedural disenrollment situation and widen that rate acuity mismatch even further over the next few years?

Gail Koziara Boudreaux, CEO

Thanks for the question. There's a number embedded in there. Maybe I'll ask Felicia to address sort of the work requirements component.

Felicia Farr Norwood, President of Government Health Benefits

No. Thank you for the question, Michael. I'll start by saying that we have very good experience in terms of work requirement programs and working collaboratively with our state partners. When it's all said and done, we've operated in multiple regulatory environments. And the expectation from us is to be a good state partner in helping them through some of the operational challenges. So we are going to be providing them with opportunities to understand how you can do this more efficiently. States certainly are always pressured when it comes to resources and staffing to support this kind of activity. And so we are there to make sure that we bring innovative programs to help them meet the needs of beneficiaries. We have that experience in Indiana, which early implemented work requirements. Georgia is another state where work requirements are in place today. And I think we've been able to work very effectively with our state partners to make sure that we are bringing the value to the table to support our states and equally important, support members and individuals who rely on Medicaid programs to make sure that they continue to have access for necessary care as we go through this period.

Gail Koziara Boudreaux, CEO

Thank you, Felicia, and thank you to everyone on the line. As you heard on the call today, we're actively addressing the levers that we can control, even as the ACA Medicaid markets go through a period of recalibration. The actions we're taking to align pricing, stabilize trend, and drive operating leverage will position us for improved performance in 2026. At the same time, we're making the right strategic investments to enhance the embedded earnings power of the business and enable the enterprise to achieve its long-term growth objectives. Thank you for your interest in Elevance Health, and thank you for joining our call today.

Operator, Operator

Ladies and gentlemen, a recording of this conference will be available for replay after 11:00 a.m. today through August 17, 2025. You may access the replay system at any time by dialing (866) 511-1890, and international participants can dial (203) 369-1945. This concludes our conference for today. Thank you for your participation and for using Verizon conferencing. You may now disconnect.