Humana Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial statements are unaudited. Humana operates health plans and healthcare services, with Medicare as its largest business.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $13.282 billion | $13.694 billion | $40.578 billion | $41.501 billion |
| Operating income | $858 million | $949 million | $3.696 billion | $2.179 billion |
| Net income | $499 million | $450 million | $2.264 billion | $1.015 billion |
| Diluted EPS | $3.44 | $2.98 | $15.44 | $6.73 |
| Benefit ratio | 82.1% | 81.5% | 83.1% | 83.6% |
| Operating cost ratio | 12.8% | 12.8% | 11.7% | 12.6% |
| Effective tax rate | 37.5% | 50.1% | 35.9% | 50.2% |
- Q3: Revenue declined 3.0% and operating income declined 9.6%, while net income rose 10.9%. The lower effective tax rate supported net income despite lower pretax income; workforce-reduction charges partly offset earnings.
- Nine months: Revenue declined 2.2%, but operating income increased 69.6% and net income more than doubled. The comparison includes a $947 million net gain, primarily the $1 billion Aetna merger termination fee received in February 2017. The 2016 period included $81 million of merger-related costs.
- Premiums fell 3.1% in Q3 and 2.2% year to date, principally because of lower Individual Commercial premiums. Retail premiums grew 2.0% in Q3 and 3.3% year to date, mainly from Medicare Advantage growth. Medicare represented approximately 78% of premiums and services revenue year to date.
- Prior-period claims reserve development was favorable by $85 million in Q3 and $430 million year to date. The year-to-date amount was lower than the $525 million in the comparable 2016 period.
Cash flow, balance sheet, and liquidity
- Nine-month operating cash flow was $6.962 billion, versus $4.709 billion in 2016. It was materially affected by the merger fee and early receipt of approximately $3.1 billion of October Medicare premiums; management also cited higher earnings and working-capital timing. Treat the reported increase as partly timing- and transaction-driven.
- Investing cash flow was a $1.776 billion outflow; financing cash flow was an $802 million inflow. Cash and cash equivalents were $9.865 billion at September 30, compared with $3.877 billion at year-end 2016.
- Total assets were $32.956 billion; current assets $23.185 billion and current liabilities $14.418 billion. Total debt was $4.930 billion, including $953 million classified as short-term; stockholders’ equity was $11.211 billion.
- Humana reported $2.0 billion of unused capacity under its revolving credit facility and no borrowings under that facility. It said available cash, investments, operating cash flow, and financing sources were adequate for expected needs for at least 12 months. Credit-agreement leverage was 1.1:1, below the 3.0:1 maximum.
- Cash returned to shareholders included $1.7 billion of share repurchases and $162 million of dividends paid during the first nine months. The quarterly dividend was increased to $0.40 per share in 2017.
Segment performance and material changes
- Retail: Q3 pretax income was $610 million, essentially unchanged; nine-month pretax income rose 25.7% to $1.587 billion. Medicare membership growth supported revenue, but the segment benefit ratio increased year over year. Individual Medicare Advantage membership was 2.849 million at quarter-end.
- Group and Specialty: Q3 pretax income rose to $93 million from $37 million; nine-month income increased to $365 million from $333 million. Q3 results benefited from favorable utilization in fully insured commercial medical plans. Group ASO membership declined 21.8% year over year.
- Healthcare Services: Pretax income declined 19.2% in Q3 to $240 million and 8.9% year to date to $754 million. Management cited chronic-care program optimization and pressure in provider services, including lower Medicare rates in relevant markets.
- Individual Commercial: Pretax income was $26 million in Q3 and $207 million year to date, but membership was down 80.3% year over year. Humana plans to exit this medical business effective January 1, 2018, citing continued signs of an unbalanced exchange risk pool.
- Humana realigned its reportable segments in 2017; prior-period segment figures were recast. The health insurance industry fee was suspended for 2017, lowering operating costs and the tax rate, and is scheduled to resume in 2018.
Outlook, unusual items, and risks
- Humana estimated that the 2018 Medicare Advantage rate notice would produce a 0.45% rate increase for the company, versus CMS’s comparable sector estimate of 0.85%, before specified adjustments including Star ratings and encounter-data effects. Medicare contracts and 2018 product offerings had been renewed or approved.
- In Q3, the company recorded $124 million of workforce-reduction charges, or $0.54 per diluted share, for programs expected to affect approximately 2,700 employees. Payments were expected primarily to begin in early 2018.
- After quarter-end, Humana agreed to sell its closed-block commercial long-term-care subsidiary. It expects an approximately $400 million net loss, including an estimated $900 million pretax loss offset by a $500 million tax benefit. Closing is anticipated by Q3 2018, subject to approvals and other conditions; the expected tax benefit and transaction completion are uncertain.
- After quarter-end, Humana sued the federal government seeking approximately $611 million in risk-corridor payments for 2014–2016. No revenue or receivable was recognized for the claim, and there is no assurance of recovery. More broadly, exchange-program receivables and regulatory changes remain uncertain.
- Other significant exposures include Medicare Advantage risk-adjustment data audits and related investigations, other regulatory and legal matters, and state guaranty-fund assessments. The filing says potential outcomes in certain proceedings cannot be reasonably estimated and could be material. A $54 million Penn Treaty-related assessment was recorded in Q1.
- Interest-rate risk is material: management estimated that a 1 percentage-point rate increase would reduce investment-securities fair value by approximately $700 million. Approximately 98% of debt securities were investment grade, with an average S&P rating of AA.
- The filing provides no clear consolidated earnings guidance. Management describes its integrated-care strategy and reports that 65.9% of individual Medicare Advantage members were in value-based relationships at quarter-end.
Most important facts for investors to verify
- How much of earnings and operating cash flow is repeatable after excluding the Aetna termination gain, Medicare premium-receipt timing, and tax benefits from the fee suspension and merger termination.
- Whether Medicare Advantage pricing, claims experience, and favorable reserve development support sustainable margins, particularly as the Retail benefit ratio rose in Q3.
- Progress, financial effects, and regulatory approval status of the Individual Commercial exit and the long-term-care sale, including realization of the expected tax benefit.
- Developments in the $611 million risk-corridor lawsuit, CMS risk-adjustment audits, and other government investigations or contingencies.
- Liquidity and capital needs after share repurchases, the long-term-care capital contribution, debt issuance, and the resumption of the health insurance industry fee in 2018.