Humana Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited interim results. Humana operates Retail, Group, and Healthcare Services segments. Comparisons are with Q1 2015 unless otherwise noted.
Financial performance and condition
| Metric | Q1 2016 | Q1 2015 / prior date |
|---|---|---|
| Total revenue | $13.800 billion | $13.833 billion |
| Operating income | $547 million | $790 million |
| Net income | $234 million | $430 million |
| Diluted EPS | $1.56 | $2.82 |
| Benefit ratio | 84.8% | 83.1% |
| Operating cost ratio | 12.9% | 14.2% |
| Effective tax rate | 53.2% | 42.2% |
| Operating cash flow | $482 million | $107 million |
| Cash and cash equivalents | $2.801 billion | $2.571 billion at Dec. 31, 2015 |
| Long-term debt / short-term borrowings | $3.793 billion / $300 million | $3.794 billion / $299 million at Dec. 31, 2015 |
Premiums rose 1.4% to $13.440 billion, while services revenue fell 46.9% to $260 million, primarily reflecting the June 2015 sale of Concentra. Benefits expense increased 3.6% to $11.397 billion. The benefit ratio worsened 170 basis points, while the operating cost ratio improved 130 basis points. Operating cash flow improved substantially, which management attributed mainly to working-capital timing, including early receipt of commercial reinsurance recoveries. Investing activities used $428 million and financing activities provided $176 million; cash increased $230 million.
At March 31, 2016, total assets were $26.934 billion, total liabilities $16.409 billion, and stockholders’ equity $10.525 billion. Humana reported $999 million of remaining capacity under its revolving credit agreement and was in compliance with its covenants, with a 1.5:1 leverage ratio versus a 3.0:1 maximum. Management stated available cash, investments, operating cash flow, and borrowing sources were adequate for at least the next 12 months.
Material changes and segment results
- Net income declined 45.6% and diluted EPS 44.7%. Retail pretax income fell $221 million, or 58.9%, to $154 million; higher premiums were more than offset by a higher benefit ratio.
- Group pretax income increased $4 million to $158 million. Premiums declined 3.9%, while the benefit ratio rose to 74.8% and the operating cost ratio improved to 24.1%.
- Healthcare Services pretax income increased $11 million, or 4.8%, to $241 million, supported by pharmacy and home-based services growth; lower provider-services profitability partly offset gains. Segment comparisons also reflect Concentra’s sale.
- Prior-period favorable medical claims reserve development was $340 million, versus $194 million in Q1 2015, reducing the consolidated benefit ratio by approximately 250 basis points versus 150 basis points a year earlier.
- Membership gains included individual Medicare Advantage (+4.5%), stand-alone prescription drug plans (+10.3%), and state Medicaid (+14.6%). Group Medicare Advantage declined 25.8%, principally following the loss of a large account; individual commercial membership declined 13.7% year over year.
Outlook, management commentary, and risks
- The Aetna merger, announced in 2015, was expected to close in the second half of 2016, subject to regulatory and other closing conditions. The stated consideration is 0.8375 Aetna shares plus $125 cash per Humana share. DOJ information submissions were completed during Q1. Merger-related transaction and integration costs were approximately $34 million, or $0.21 per diluted share, in the quarter.
- Management estimated 2017 Medicare Advantage funding would decrease approximately 1.3% on average, based on the final rate notice and other adjustments; geographic effects may vary. Humana was developing 2017 individual commercial offerings and anticipated possible market or product exits, service-area reductions, and pricing changes.
- Management expected a 2016 effective tax rate of approximately 49%–51%, excluding merger transaction costs incurred after March 31. The estimated 2016 health insurer fee was $908 million and is nondeductible. A one-year 2017 suspension of the fee is expected to reduce operating costs and the effective tax rate that year.
- The individual commercial business compliant with health reform continued to face adverse selection, elevated claims, and enrollment volatility. Humana recorded a $176 million premium deficiency reserve in Q4 2015; it increased by $13 million to $189 million at March 31, 2016. Management continued to anticipate a full-year 2016 loss for this business.
- Risk corridor and reinsurance settlements create timing and collectability exposure. The net receivable associated with health reform’s risk-adjustment, risk-corridor, and reinsurance programs was approximately $759 million at March 31, 2016. The filing notes potential funding shortfalls for risk-corridor payments and uncertainty over government audit methodology.
- Material risks include Medicare Advantage risk-adjustment audits and related investigations, provider coding and documentation, government contract renewals and rate changes, regulatory actions, and pending litigation. The filing says potential losses beyond recorded accruals could not be estimated and that outcomes could materially affect results, financial position, cash flows, or reputation.
- Humana reported $64 million of gross unrealized investment losses, primarily attributed to interest-rate changes, and no material other-than-temporary impairments. Management did not intend or expect to be required to sell the affected securities before recovery. A 1-percentage-point increase in interest rates was estimated to reduce securities fair value by approximately $475 million.
Important facts for investors to verify
- Progress and conditions for the Aetna merger, including regulatory approvals, litigation, and any transaction-related costs or debt-rating consequences.
- Whether Retail benefit costs, Medicare Advantage funding changes, and favorable prior-period claims development persist or reverse.
- Actual performance and reserve adequacy of the individual commercial health-reform business, including the $189 million premium deficiency reserve.
- Timing and collectability of health-reform program receivables, CMS risk-adjustment settlements, and any RADV audit liabilities.
- Whether strong reported operating cash flow is repeatable, given management’s attribution to working-capital timing, and the effect of regulated-subsidiary capital and dividend restrictions on parent liquidity.