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Magellan Health Inc (MGLN)
Q3Â 2019 Earnings Call
Nov 1, 2019, 8:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Welcome and thank you for standing by for the third quarter 2019 earnings call. [Operator Instructions] Today's conference is being recorded. If you have any objections you may disconnect at this time.
Now I will turn the meeting over to Joe Bogdan. Thank you. You may begin.
Joe Bogdan -- Senior Vice President, Corporate Finance
Good morning, and thank you for joining Magellan Health's third quarter 2019 earnings call. With me today are Magellan's CEO, Barry Smith; and our CFO, Jon Rubin. We're also fortunate to have our incoming CEO, Ken Fasola on the call as well. While he won't be taking any questions today. His first day at Magellan will be November 14th and he will be on our 2020 guidance call in December.
The press release announcing our third quarter earnings was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through December 1st. The numbers to access the replay are in the earnings release.
For those who listen to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today, Friday, November 1st, 2019 and have not been updated subsequent to the initial earnings call. During our call, we will make forward-looking statements, including statements related to our growth prospects and our 2019 outlook.
Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations, and we advise listeners to review the risk factors discussed in our press release this morning and documents we filed with or furnished to the SEC.
In addition, please note that Magellan uses certain non-GAAP financial measures when describing our financial results. Specifically, we refer to segment profit, adjusted net income, and adjusted EPS, which are defined in our SEC filings and in today's press release. Segment profit is equal to net revenues less the sum of cost of care, cost of goods sold, direct service costs, and other operating expenses, and includes income from unconsolidated subsidiaries, but excludes segment profit from non-controlling interests held by other parties, stock compensation expense, special charges or benefits as well as changes in the fair value of contingent consideration recorded in relation to acquisitions.
Adjusted net income and adjusted EPS reflects certain adjustments made for acquisitions completed after January 1st, 2013 to exclude non-cash stock compensation expense resulting from restricted stock purchases by sellers, changes in the fair value of contingent consideration, amortization of identified acquisition intangibles as well as impairment of identified acquisition intangibles. Please refer to the tables included with this morning's press release, which is available on our website, for a reconciliation of these non-GAAP financial measures to the corresponding GAAP measures.
I will now turn the call over to our CEO, Barry Smith.
Barry M. Smith -- Chief Executive Officer
Thank you, Joe. Good morning, and thank you all for joining us today. On our call this morning, I will comment on the financial results for the quarter and a reduction to 2019 guidance.
I also highlight business and operational developments, including progress on our margin improvement initiatives. For the third quarter of 2019, we reported net revenue of $1.8 billion, net income of $21.3 million and EPS of $0.86 per share. Our adjusted net income was $30.2 million or $1.23 per share and we achieved segment profit of $72.2 million.
Results for the quarter were solid in MCC and Pharmacy, but we are lowering our 2019 earnings guidance primarily due to the following two factors. Cost of care pressure in our behavioral and specialty health business, and severance charges related to our operational improvement initiatives.
As I'll discuss these pressures are short-term in nature and should not affect progress toward our margin goal of at least 2% adjusted income by 2021. Later in the call, John will provide additional details on our quarterly financial results. Our updated 2019 earnings guidance and some initial commentary on our outlook for 2020.
Now let me highlight some specific developments within our business during the third quarter and the progress we are making toward our margin improvement plan. Within our Magellan Complete Care portfolio of managed medicaid health plans, we continue to execute against our medical action plans toward the goal of achieving industry-competitive margins.
In addition to reducing costs, our team remains focused on improving the quality and associated outcomes from the medical services provided to our members. In Virginia, I am pleased to report that our efforts to improve the cost of care continue to show progress. Our medical loss ratio for the quarter was in the low '90s.
The focus of our medical action plans does not changed in Virginia. We continue to drive value through the appropriate management of inpatient, outpatient, and personal care services as well as claim payment integrity reviews.
For example, we've been successful in managing outpatient behavioral health services where we approach care coordination on a member-centric basis. The key is understanding what's best for the member and proactively connecting them to the appropriate care, while avoiding waste and duplicated services.
These upfront interventions also prevent increases in inpatient hospitalizations and ER visits. While we still have work to do to reach out to our target margin in Virginia, we feel good about the continued progress we've made to-date in 2019.
Regarding our New York plan, we highlighted our second quarter earnings call in a call that we were awaiting updated capitation rates for the current fiscal year. I'm pleased to report that we've received these new rates and they are largely in line with our expectations, including an update to our risk scores to reflect the increased acuity of our population.
Now turning to our behavioral and specialty health business. We have experienced an increase in cost of care, particularly for inpatient admissions within our behavioral health business. We are currently working on action plans to mitigate the impact. I'd also note that our customer contracts allow for annual resetting of capitation rates to reflect emerging experience and anticipated future trend.
So, while these cost pressures affect our 2019 earnings outlook, we do not expect a material ongoing impact in 2020. With respect to product development, we have recently deployed an industry-leading automated prior authorization solutions called Decision Point. The tool will provide clinical guidelines predetermine the medical necessity of certain imaging procedures to inform providers and enable authorization determinations in real-time through full integration at the point of care because providers are increasingly accountable for the cost of care of their patients, we see this as a new growth channel, and are currently piloting the program with a number of provider groups.
Now let me provide you with some quarterly operational highlights for Magellan Rx. Throughout 2019, we have been actively working toward our strategic priority of lowering the cost of goods sold through negotiations with our network pharmacies, manufacturers and wholesalers. I'm pleased to report that to-date, we renegotiated 98% of the supply chain creating savings for our customers, while also improving our gross margin.
Our pharmacy team has also been broadening and deepening our specialty carve-out services to retain existing and attract new customers. We continue to evaluate therapeutic classes of drugs, where there is an increase in competition, which enhances our opportunity to develop management strategies that create savings, while maintaining or improving quality of care.
The US Food and Drug Administration has recently reported that biologics are the fastest growing class of therapeutics. Earlier this year in response to the growing biologic spend, we expanded our formulary management program into therapeutic classes such as oncology biosimilars and medical benefit biologics to treat asthma.
In preparation for the expanded market entry of oncology biosimilars, we've also expanded our medical pharmacy management program into a comprehensive solution that aims to educate consumers, customers, members, and providers.
These expanded products and services are already gaining solid traction with our client base. In our PBM book of business, we continue to see traction with large employer accounts in our core middle market employer business. We feel good about our prospects for 2020 organic growth and retention rate.
We will share more details since our a plan was finalized in early December. In addition, we are pleased to share that Magellan Rx management was recently accredited by NCQA for utilization management. This recognition reflects the high quality of medical management that we provide to our customers and their members.
In our Part D business, our bid rates were below the benchmarks in three out of four regions that we did. And as a result, we estimate to retain 80% to 90% of our current membership in 2020. As we mentioned in the past, our entry into the PDP business was primarily designed to gain the necessary experience to serve the managed care PBM market.
One of the key elements to our multi-year margin improvement strategy is reducing our administrative costs. We continue to review and execute against opportunities to improve efficiency across all of our businesses through our efforts to accelerate platforms, remove redundancy, and right-size operations.
As I noted earlier, we plan to incur severance charges later this year, which reflects the anticipated 2020 implementation of several of these initiatives. Some of these things will contribute to our future margin expansion target and another is will be used for funding investments for our business. We'll provide more details during our 2020 guidance call in December.
Before turning the call over to John, I'd like to emphasize that the headwinds facing us this year are short-term in nature and should not affect the pace of our margin improvement plan. We continue to see significant long-term opportunity for both growth in our healthcare and pharmacy businesses. And we remain focused on improving the adjusted net income margin for the company to at least 2% by 2021.
Now I'll turn the call over to our Chief Financial Officer, Jon Rubin. Jon?
Jonathan N. Rubin -- Chief Financial Officer
Thank you, Barry, and good morning, everyone. On today's call, I'll review the third quarter results, discuss our revised outlook for 2019 and provide some initial commentary on our 2020 business plan.
For the quarter, revenue was approximately $1.8 billion, which is relatively consistent with the same period in 2018. Growth in MCC, Virginia and new business were essentially offset by MCC Florida and Medicare Part D footprint reductions as well as the previously discussed PBM health plan contract loss due to an acquisition.
Net income was $21.3 million and EPS was $0.86. This compares to net income and EPS of $27.1 million and $1.9 respectively for the third quarter of 2018. Adjusted net income was $30.2 million and adjusted EPS was $1.23. This compares to adjusted net income of $36.2 million and adjusted EPS of $1.45 for the prior year quarter. Segment profit was $72.2 million for the third quarter compared to $88.3 million in the prior year quarter.
Now for our healthcare business, segment profit for the third quarter of 2019 was $44.7 million versus $61.7 million in the third quarter of 2018.
Healthcare results for the current quarter include net favorable out of period adjustments of approximately $4 million, compared to $22 million of net favorable out of period adjustments in the prior year quarter. Adjusting for these out of period items, segment profit was $1 million higher than in the prior year quarter.
This net increase in segment profit is driven by progress on our cost of care initiatives in Virginia, offset by cost of care pressure in the Behavioral and Specialty Healthcare business as well as lower discretionary benefit expenses in 2018.
As Barry mentioned, we're seeing an increase in demand for behavioral inpatient services this year. We're currently in negotiations with key behavioral customer on our 2020 rate renewals, which will incorporate this recent experience. So, we don't expect significant earnings pressure to continue into 2020. In addition, we're continuing to strengthen and execute our care management programs, particularly inpatient concurrent stay reviews and targeted network initiatives.
Turning to pharmacy management. We reported segment profit of $35.4 million for the quarter ended September 30th, 2019, which was an increase of 5.2% from the third quarter of 2018. This year-over-year increase was primarily driven by growth and improved profitability in our Magellan Rx Specialty division.
Regarding other financial results. Corporate costs inclusive of eliminations, but excluding stock compensation expense, totaled $8 million compared to $7 million in the third quarter of 2018. Total direct service and operating expenses, excluding stock compensation expense and changes in fair value of contingent consideration were 14.3% of revenue in the current quarter compared to 13.8% in the prior year quarter.
This increase was primarily due to lower discretionary benefit expenses in the prior year quarter and a change in business mix. Stock compensation expense for the current quarter was $4.8 million, a decrease of $4.5 million from the prior year's quarter.
This reduction is primarily due to timing related to vesting of certain equity awards. The effective income tax rate for the nine months ended September 30th, 2019 was 31.2% versus 26.3% in the prior year. The 2019 year-to-date tax rate is higher than the comparable 2018 rate mainly due to book to tax differences related to stock compensation expense, partially offset by the suspension of the health insurer fee in 2019.
We anticipate a full-year effective income tax rate of approximately 31%. Our cash flow from operations for the nine months ended September 30th, 2019 was $144.4 million. This compares to cash flow from operations of $34 million for the prior year period.
This year-over-year improvement is primarily related to favorable working capital changes and lower tax payments. As of September 30th, 2019, the company's unrestricted cash and investments totaled $220.3 million compared to $130.4 million at December 31st, 2018.
Approximately $105.4 million of the unrestricted cash and investments at September 30th, 2019 is related to excess capital and undistributed earnings held at regulated entities. Restricted cash and investments at September 30th, 2019 decreased to $500 million from $527.7 million at December 31st, 2018. This decrease was primarily due to changes in working capital of our regulated subsidiaries.
Now as Barry mentioned, we're lowering our earnings guidance. The primary drivers for the reduction are first, pressure in our Behavioral and Specialty Healthcare business primarily related to higher than anticipated demand for behavioral inpatient services, and second an estimate of severance and other costs that we expect to recognize later in 2019.
Specifically, we are revising our 2019 full-year earnings guidance ranges to the following. Net income of $47 million to $65 million, EPS in the range of $1.92 to $2.65, adjusted net income of $82 million and $98 million, adjusted EPS in the range of $3.35 to $4 and segment profit of $245 million to $260 million. We're maintaining our current revenue guidance range of $7 billion to $7.2 billion.
As I noted previously with key rate renewals and progress for our behavioral health customer contracts, we believe we will mitigate the majority of this earnings pressure in 2020. We're in the process of finalizing our business plan for 2020 and will provide detailed guidance in early December. In advance of the 2020 guidance call, I'll now provide some high level commentary.
To start, the midpoint of our revised 2019 guidance range for segment profit needs to be adjusted by two factors to arrive at a run rate. First, approximately $22 million of combined net favorable year-to-date out of period adjustments an estimated fourth quarter severance charges. Second, approximately $12 million of additional segment profit in 2020 related to the provision for non-deductibility of the health insurer fee, which we expect to be reinstated.
After adjusting for these two items, our 2019 normalized segment profit run rate would be in the range of $235 million to $250 million. We expect that 2020 segment profit will be significantly higher than this normalized 2019 segment profit range.
And key drivers of this segment profit increase in 2020. Our continued execution against cost of care initiatives for MCC Virginia and other healthcare contracts, rate increases in our healthcare business in excess of care trend and net business growth.
In closing, our results for the quarter in MCC and Pharmacy were solid. Despite the short-term pressure we're seeing in our Behavioral and Specialty Healthcare business, we're making good progress on our profitability improvement initiatives and are well positioned to achieve earnings growth in 2020 and beyond.
And with that I'll now turn the call back over to Barry. Barry?
Barry M. Smith -- Chief Executive Officer
Thanks, Jon. As we end today's call, I am delighted to introduce Ken Fasola as Magellan's new Chief Executive Officer to succeed me effective November the 14th, 2019. The Board and I are all pleased that we're able to have to attract such a capable individual of Ken's caliber, who has broad healthcare experience and a proven leadership track record.
Ken has had a successful leadership career spanning three decades in the healthcare industry. He has held key executive roles at Humana, UnitedHealth Group and the Blue's in business operations, marketing and sales. Most importantly, he has served as President and Chief Executive Officer of HealthMarkets, one of the largest health insurance agencies in the US, which was acquired earlier this year by UnitedHealth Group.
I know the Board is looking forward to working closely with Ken in Magellan's Executive leadership team to continue the next phase of growth for the company. I've agreed to assist with the transition as needed. On a personal note, I am grateful to the Board and our executive leadership team and Magellan's 10,000 employees for their commitment and dedication to Magellan Health, its members, customers, and investors.
Over the past seven years, the company experienced a period of expansion through organic growth and strategic acquisitions. Magellan's portfolio of businesses, Magellan Complete Care, Magellan Behavioral and Specialty Health and Magellan Rx Management are poised for future success.
I'd like to welcome Ken into the call and ask that he share a few comments. Ken?
Kenneth J. Fasola -- Chief Executive Officer
Thank you, Barry, and good morning. I appreciate Barry's and the Board's confidence and I'm honored to be named Magellan's CEO. I'm looking forward to leading Magellan and would highlight several distinct advantages we have built from. It's been said that great companies well defined by the leaders are in fact built by their people.
Magellan has a team of highly skilled, committed, mission-driven employees, anchored around a culture that values respect and caring and proven expertise in managing complex population health across our three business lines.
These advantages will serve us well in today's rapidly evolving healthcare marketplace. Over the coming months I plan to dedicate time with key stakeholders, the Board of Directors, and Magellan's executive leadership team to refine our strategy and lead this company into its next phase of growth.
I look forward to meeting those of you on the call in the very near future and with that, Barry. I turn it back over to you.
Barry M. Smith -- Chief Executive Officer
Great, thank you, Ken. And with that, now I'll also turn the call back over to the operator, who will be happy to take your questions. Operator?
Questions and Answers:
Operator
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question or comment comes from Kevin Fischbeck from Bank of America. Your line is open.
Kevin Fischbeck -- Bank of America -- Analyst
Great, thanks. Just want to go into the behavioral issues in the quarter. Can you talk a little bit about, you said, that you don't really expect much of an impact in 2020. How much of that offset is coming in the form of rate increases versus some of the operational costs and network changes that you're making?
Jonathan N. Rubin -- Chief Financial Officer
Hi, Kevin, it's John. Let me start on that. First, really as we think about the pressures in behavioral, which were driven by demand for inpatient services and our means of addressing it. There's really two main things that we're doing.
One is as noted on the call, on our prepared remarks, working with customers as we're negotiating rates into 2020 to make sure that those rates reflect both the baseline experience that we've seen as a result of the increased demand and the trends that we're seeing in the business. So, that's something again that's in progress now and we expect to be completed hopefully by the end of the year in first quarter.
Second, really is the action plans on the care management side both concurrent review for inpatient stays, contracts are generally per diem although we have a mix of contracts, we are making progress on that and looking for further improvement and also on targeted network initiatives because we've identified some facilities that are outliers and we've seen some change in mix of services to some of the higher cost facilities. So, well, I'd say, the relative rate weighting of those things, the rates will likely have a bigger near-term impact both will be important as we drive progress going forward.
Barry M. Smith -- Chief Executive Officer
The only other thing I would add to Jon's comment is that when we see these underlying shifts in the population, we do have agreements with our clients that we can renegotiate our rates based upon that increased demand, because the population is fundamentally different.
And it's some of our accounts we have seen it on the MCC side as well as the commercial side as well. When you have unanticipated populations that have different impacts on utilization and demand, we typically able to renegotiate in a way that keeps us whole and allows us to have our normalized margins. And so we expect to see that in this case.
Kevin Fischbeck -- Bank of America -- Analyst
And this ability to kind of recontract is this that -- is this in the normal repricing cycle and you got this some time for that or you're saying that your contracts kind of allow for even unexpected changes in the utilization throughout the year. You have an ability to go back and recontract that?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, Kevin, right now we are in the normal cycle. So, where the timing is good for us because we're just heading into those negotiations like I said in many cases with some of the largest -- most critical customers those are already ongoing. So, while our contract do allow reopeners under certain circumstances in this case, we are actually in the normal cycle, which actually facilitates this.
Kevin Fischbeck -- Bank of America -- Analyst
Okay. And then the Virginia contract. It sounds like you're doing well there these at low 90s MLR. I think the guidance you said was that you want to be at 90% MLR there. Is that still what you think the ultimate target is or are there still opportunity to go below that?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, I'd say there's some opportunity to go below that, I'd say 90% would be where we think we need to at least to get into the normal profit margin range, but our objective would be to do 90% or better. But we think we are based on where we are 90% over the foreseeable future is very reasonable.
Barry M. Smith -- Chief Executive Officer
And Kevin we've had great success this year in managing costs appropriately with both the in-patient utilization management, claims integrity, outpatient costs. So, we've seen the kinds of initiatives have material impact. The other thing is that many of the initiatives that we deploy even in late 2018, we haven't seen full yet the positive impact of those. They are still emerging in a positive way. So, we expect to see value throughout this year, but also into 2020, which gives us great hope for normalized margins in the near future there.
Kevin Fischbeck -- Bank of America -- Analyst
Great. And then on the Magellan Rx side, I guess, you said you've gone to 98% in the supply chain. How do we think about this is something that you guys do kind of annually and it felt like maybe you are a little bit later to that process this year than normal. How do we think about the ability to go back next year and get additional savings. Is it going to be kind of the same pace and timing or should we see it be a little bit more front-end loaded?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, I would say, I mean, Kevin, what you said is true. I mean it is a continuous process that you never done. What I would say though is that some of the initiatives we undertook this year were beyond just the normal annual recontracting.
We actually did a full RFP for a wholesaler contract for example and did change wholesalers to affect cost improvement and get the best possible terms. So, you're right that it is an annual process, and what I'd say is we'll get the full benefit next year of what we implemented this year, much of which wasn't implemented until second quarter this year.
So, we'll get some annualization of that next year and then next year like you said we'll go through the normal process of as we grow the business and as we have opportunities to affect additional savings.
Barry M. Smith -- Chief Executive Officer
In fact as kind of building on Jon's comment there, we've seen greater and greater success with larger and larger clients both in the MCO world, but also on the commercial side as well.
And because of that incremental volume we're able to go back to network, particularly, we have density in certain geographic areas and negotiate better pricing with our network, and also on the specialty side negotiate better deals for both our clients, which enhance our margins as well.
So, it works well, we've seen that progress over the last several years, but it really continues, it's kicking into higher gear now and then, I think, I've seen it in the past.
Kevin Fischbeck -- Bank of America -- Analyst
And then maybe last question. On the severance initiatives and operational improvements. So, I'm just trying to understand kind of how that impacts this year's numbers versus next year's numbers because it sounds like you've got extra costs in this year's numbers that you're not really excluding from the core results, which would go away to some degree next year plus you'd be generating savings, some of which gets reinvested, but some of which passed to the bottom line. So, just trying to understand, is there anyway that you can quantify at the very least kind of the severance cost that you're taking on this year versus kind of the return on those investments you expect over the next year or two?
Jonathan N. Rubin -- Chief Financial Officer
This is Jon. So, two general comments again we'll provide more detail on next year's budget in December. We're still finalizing the plan. So, I don't have precise numbers for you. But in terms of severance what we currently, what we're currently expecting order of magnitude it's about $5 million of severance in fourth quarter and that number we will refine as we kind of complete our plans and go through the next month or so.
But that's the least ballpark, what we're expecting at this point. In terms of next year and exactly how much of these savings will be reinvested versus will accrue to our benefit short-term. Those things we're still working out and we'll kind of have a updated view on as we go to guidance call.
The only other note, I'd make is, if you recall last year when we talked or even earlier this year. We said, we have about $35 million of incremental expense savings opportunities beyond what we signed up for and achieved in 2019.
That won't be necessarily in 2020, but that if you think about our two or three year path to getting to fully competitive margins that's order of magnitude the amount that we believe we have left and have the opportunity to achieve over the next couple of years.
Kevin Fischbeck -- Bank of America -- Analyst
Okay. And just to make sure that 235 to 250 kind of normalized base that you talked about for 2019. Does that exclude the severance costs or is that still includes the severance costs?
Jonathan N. Rubin -- Chief Financial Officer
That's excluded. So, it was one of the things we adjusted out.
Kevin Fischbeck -- Bank of America -- Analyst
Okay. So, that 235 is a good base, it has the severance out.
Jonathan N. Rubin -- Chief Financial Officer
Yes.
Kevin Fischbeck -- Bank of America -- Analyst
Okay, thank you.
Jonathan N. Rubin -- Chief Financial Officer
You bet.
Barry M. Smith -- Chief Executive Officer
Great. Thanks, Kevin.
Operator
Thank you. Our next question or comment comes from Dave Styblo from Jefferies. Your line is open.
David Styblo -- Jefferies -- Analyst
Hi, there. Good morning. And I guess to start out with Ken welcome on over. I'm looking forward to working with you and Barry, I guess, maybe this is the last time we will probably hear from you on the call. So, I just want to say thanks for perspective and enjoyed working with you over the years. I want to just come back to understand the guidance. So, it sounds like based on response to Kevin's question of the $25 to $30 million segment profit about $5 million of that is related to severance. I know you guys talked about other costs in there. I just want to make sure that I'm thinking about that right that it's $5 million there and call it $20 million plus related to the healthcare earnings that are dampened. Is that sort of the right split?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, I'd say, ballpark, Dave that's right. I would say that of the two items I specifically noted, it's around $5 million in severance and around $15 million on the behavioral specialty cost of care side. But you're right, I mean, there is handful of other things, smaller things that added up and as well. We did have some pressure in the first half of the year, which while we were still in the guidance range would have potentially pulled us a little bit below mid point. So, but round numbers, I think, I've used 5 and 15 and then the rest again either rounding in terms of where we were versus midpoint or a handful of other smaller things.
David Styblo -- Jefferies -- Analyst
Okay. And then on the severance, I guess, you guys had announced this initially thinking this extra savings back in December a year ago at the guidance call. Just curious what may have changed as you've evaluated the year to include some more severance cost. I would have thought that these would have originally been baked into guidance though and sort of the plans that you guys have. Is there something that got pulled forward or change that is now causing the severance cost to land in the four quarter of this year?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, I would say, Dave it's just having increased specificity now in terms of the plans and timing, and also if you can imagine as we go into the planning phase, we're also looking at the volumes that we have to deal within the following year.
So, whether we're able to achieve the expense reductions with or without further reductions in workforce or requiring additional severance would be based on what growth looks like in the following year as well. So I wouldn't look at it as materially different I would look at it as fine tuning of kind of our multi-year plan and the timing of it.
David Styblo -- Jefferies -- Analyst
Okay, got it. And then on the behavioral specialty issues. Can you, Jon, maybe you can elaborate a little bit more on how widespread the increased utilization is. Does it related to a certain pockets of employer groups or into a certain geography or is this very broadly spread across the book. And why do you guys think you're all of a sudden seeing this now?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, I mean, that's a great question David and one that honestly we're spending a lot of time trying to gain further understanding of. It is relatively widespread, meaning, it's not just one account. I mean, obviously there's certain large accounts where it adds up to more, but we are seeing this increased demand for inpatient and it's really primarily behavioral health.
We're seeing that across a variety of accounts and population. So, it does seem like it's more of a sort of broad market phenomenon rather than either anything specific to things we're doing or in a particular customer, but in terms of really trying to get down and understand are there any sort of specific caused us versus just general demand or industry trends right now we're seeing it be more widespread in nature.
Barry M. Smith -- Chief Executive Officer
And Dave the only thing I would add to that is that in some accounts, given the fact that you see churn in populations, you're bringing on new populations, who not have been covered in the past particularly in the Medicaid world or on the MCC side again individuals new populations bringing on, may not have had access, the fact that we are well known and there is a relationship already in place and Magellan being a provider for behavioral health. We do believe that does have an impact on the populations that we typically attract or receive. And so those are underlying trends we're trying to understand better, but they do seem to have an impact.
David Styblo -- Jefferies -- Analyst
Okay. And I'm sure from a competitive standpoint negotiation you probably don't want to say too much, but can you give us a sense of, I guess, about $15 million cost drag on this. How much revenue is related against that $15 million and just trying to get a sense of, OK, how much of a rate increase ballpark do you guys need next year as you go through to feel good about getting back to kind of a normalized profit on the business. And is there, I was going to say, and is there any sort of restrictions in terms of regulators that may cap you on how much you can increase the rates for next year?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, I would say, Dave it's really much more of a negotiation. We need to get our primarily health plan customers in the behavioral specialty segment and behavioral health, we're talking about.
And I looked at it really more sort of the normal course of negotiating. So no regulatory constraints because again these are commercial customers and we're a subcontractor really more arms length negotiations and from a contract standpoint, we often have sort of defined rate methodology was taken into account both the underlying baseline experience over the period and the actual trends.
Now having said that, it is a negotiation. So, while there are no hard constraints. It is something that we're working hard to educate customers on and get to the right place on. Yeah, I'd rather not speak at a customer level about what rates are required. It does vary by customer, but we think it is manageable to make up the vast majority of the current shortfall. And again those discussions are well under way.
David Styblo -- Jefferies -- Analyst
All right. Good. Last one. I'll let others but what for the 2019 guidance now. What does that assume for the Virginia margin. What's embedded in there?
Jonathan N. Rubin -- Chief Financial Officer
For the full year?
David Styblo -- Jefferies -- Analyst
Right, yeah.
Jonathan N. Rubin -- Chief Financial Officer
Yes, it's still what we've talked about earlier and then sort of the low '90s. So, it would be really, really a continuation of the type of experience we've seen to-date. And, again, we're feeling pretty good based on where we are right now.
David Styblo -- Jefferies -- Analyst
So, to be more specific, pre-tax margin, what is the assumption?
Jonathan N. Rubin -- Chief Financial Officer
It's pretty close to break-even, when you're running in the low '90s, if that was the question.
David Styblo -- Jefferies -- Analyst
Yeah, OK. Thanks, guys.
Barry M. Smith -- Chief Executive Officer
Great. Thanks, Dave. It's been wonderful working with you as well. And all I can tell you, you're getting a great big upgrade with Ken coming on board. So, we're all thrilled to have him and I'm sure you'll enjoy working with him as well. Thank you.
David Styblo -- Jefferies -- Analyst
Great. Thanks, Barry.
Barry M. Smith -- Chief Executive Officer
Thank you.
Operator
Thank you. [Operator Instructions] Our next question or comment comes from Scott Fidel from Stephens. Your line is open.
Scott Fidel -- Stephens -- Analyst
Hi, thanks. And first of all, Barry, best wishes on your retirement and congrats to Ken on coming on board as CEO. I'm looking forward to catching up with you soon and hearing your thoughts on the future strategy. So, first question just on sort of keeping on the new sort of behavioral cost issues. How would you guys sort of describe the sequencing of how that emerged during the third quarter. Did that start picking up earlier in the quarter or later? And then just in terms of -- from the claims experience and reserve development side. What if you seen on sort of a look-back basis in terms of claims coming in, in terms of what that's implying for maybe how when these issues maybe started to emerge in the first half of the year or not as well?
Jonathan N. Rubin -- Chief Financial Officer
Yes, Scott, great question. The way I describe it is, we saw some pressure emerging in the first half of the year, but it seemed within sort of normal range of seasonal volatility.
So, we had assumed that the modest increase in demand we saw in the first half of the year was more sort of seasonal in nature and wasn't -- and we expected things to return to normal in the second half of the year. In third quarter, we saw claims come in high and we also had about $3 million in this particular segment of unfavorable development related to the first half of the year.
So, we saw in the first half actually restated unfavorably and then additional pressure in third quarter. I mean, now we've kind of incorporated the new run rate into the full-year outlook. So, in terms of the progression that's how I best describe it.
Scott Fidel -- Stephens -- Analyst
Got it. And Jon do you feel at this point just in terms of keeping the reserving up to date with these emerging trends maybe talk about on the reserve side sort of your confidence that you are building in enough conservatism into the reserves. If you do see these trends continue -- are you building in that data or essentially leveling out or are you building some additional conservatism that some of these trends may potentially continue to accelerate?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, no, I mean, we have refined our methodology based on what we know and based on the emerging trends. And again if you look at second quarter restated and you look at third quarter now -- the relatively level so in fact going in to fourth quarter. It's not like we're seeing a huge uptick. Now we've got a much better picture of both second quarter and third quarter and feel like we're appropriately reserved and forecast now for the fourth quarter, I mean, I hope it ends up being conservative, but we think we've got a pretty good beat now on the full year.
Scott Fidel -- Stephens -- Analyst
Got it. And then just on the New York side of things. Just to level set on that. It has to be in terms of the rate increases and the updated risk scores did that pretty much come in pretty much spot on with what you had built into the guidance for the year or was there any sort of variance in terms of either a little bit more favorable or negative relative to what you had in the plan?
Jonathan N. Rubin -- Chief Financial Officer
Yeah, actually, it was pretty -- it was pretty much what we expected. I mean if you recall, we said we expected the rate changes to be worth sort of $20 million to $25 million over the second half of the year that was what we originally expected.
I mean I'd say ballpark we came in pretty close to that in terms of New York overall. The base rates were a little bit lower than expected and the risk adjusted is a little bit higher in terms of the components, but the overall we came in pretty close. And obviously some of that was retroactive to second quarter if you recall it was a 4.1 on the effective base that we did have some out of period favorability as well as obviously the benefit in the third quarter.
Scott Fidel -- Stephens -- Analyst
Got it. And then just one last one for me just relative to the updated guide. And so it's still as a pretty wide implied range in the 4Q. Jon, maybe you want to sort of highlight sort of key swing factors in terms of what you're building in at the higher end relative to the lower end. I'd assume that maybe some of that relates to how much rate you start getting for the behavioral and specialty issues and then maybe also within that dynamic sort of what's embedded sequentially around pharmacy margins. Clearly that was a bright spot in the quarter in terms of the pharmacy business continuing to improve. And just sort of interested and sort of what you're thinking in terms of margins for the Rx business in 4Q. And that's it for me. Thanks.
Jonathan N. Rubin -- Chief Financial Officer
Okay. Yeah, in terms of the pharmacy piece of it. We did see good margins in the quarter. What I'd say is if you look at the last couple of quarters and pharmacy. We have run reasonably well. We'd expect to continue at that general level of margin. So, I think, that should be pretty stable as we complete this year and as well as we go into next year. I'm sorry, Scott, can you repeat the first part of the question again?
Scott Fidel -- Stephens -- Analyst
Sure, Jon. Just in terms of the wide range still on sort of the implied 4Q guide and sort of the swing factors to the high-end to the low-end. My assumption was maybe that's sort of reflects how much rate you get on to reflect some of the costs if you are seeing in the behavioral and specialty, but just interested in sort of what some of those swing factors are that drive pretty wide range still on the implied 4Q guide?
Jonathan N. Rubin -- Chief Financial Officer
Okay, got it. Sorry about that. Yes, so one -- no it's not the behavioral rate. Those are really 2020 negotiations that we're going through now, but really won't have an impact on 2019. I wouldn't read a whole lot into the range kind of being plus or minus $7 million, $7.5 million.
I would just look at it as there are factors that there's always some level of volatility and obviously cost of care is one. On the rate side, there's always things we're negotiating generally those are more favorable in nature which states around restores and rates for different facets of the population that have some opportunity.
We talked about severance charges. Those are things we'll fine tune as we go through the balance of the year. I'd say those are really the key items. I mean again the further you get near, the more confidence we have -- we have narrowed the range. So, like I said, it wouldn't attach a whole lot of significance to the [Indecipherable] of the range rather than we try to make sure we are forecasting in a way that we've got confidence of being within the range.
Scott Fidel -- Stephens -- Analyst
Yeah. Got it. And probably, I guess, that wide range is more related to EPS actually than the segment profit dynamics. So, again probably just the reality it was smaller share count as well. So, I appreciate that clarification. Thank you.
Jonathan N. Rubin -- Chief Financial Officer
Got it.
Operator
Thank you. And I'm currently showing no further questions or comments at this time. I would now like to turn the call back over to Barry Smith for closing comments.
Barry M. Smith -- Chief Executive Officer
We thank you all today for attending our third quarter earnings conference call. Take care.
Operator
[Operator Closing Remarks]
Duration: 50 minutes
Call participants:
Joe Bogdan -- Senior Vice President, Corporate Finance
Barry M. Smith -- Chief Executive Officer
Jonathan N. Rubin -- Chief Financial Officer
Kenneth J. Fasola -- Chief Executive Officer
Kevin Fischbeck -- Bank of America -- Analyst
David Styblo -- Jefferies -- Analyst
Scott Fidel -- Stephens -- Analyst
