Humana Inc. 2014 Q3 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2014, compared with the same 2013 periods. Humana operates Retail, Employer Group, and Healthcare Services segments, with Medicare products representing approximately 73% of premiums and services revenue for the first nine months of 2014. The company recast prior-period segment information to reflect internal reporting changes.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $12.238 billion | $10.319 billion | $36.172 billion | $31.126 billion |
| Operating income | $589 million | $621 million | $1.991 billion | $2.075 billion |
| Net income | $290 million | $368 million | $1.002 billion | $1.261 billion |
| Diluted EPS | $1.85 | $2.31 | $6.39 | $7.90 |
| Benefit ratio | 83.3% | 83.3% | 82.9% | 83.2% |
| Operating cost ratio | 15.6% | 15.1% | 15.4% | 14.4% |
| Effective tax rate | 47.5% | 37.2% | 46.8% | 36.0% |
For the nine months, operating cash flow was $1.425 billion, down from $1.732 billion; investing cash flow was negative $368 million and financing cash flow was positive $510 million. Cash and equivalents were $2.705 billion at September 30, versus $1.138 billion at December 31, 2013.
Total debt, including current maturities, was $4.338 billion, compared with $2.600 billion at year-end 2013. Current debt was $512 million. The company had $995 million available under its revolving credit agreement and reported covenant compliance (leverage ratio 1.8:1 against a 3.0:1 maximum). Investment securities totaled about $10.0 billion in fair value; approximately 96% were investment-grade.
Material changes versus prior comparable periods
- Revenue rose 18.6% in Q3 and 16.2% for the nine-month period, primarily on Medicare Advantage, Medicare Part D, and individual commercial membership growth.
- Net income declined 21.2% in Q3 and 20.5% for the nine-month period. Higher operating costs, including health reform assessments and exchange/state-contract investments, and increased specialty drug costs—particularly a new Hepatitis C treatment—offset revenue growth.
- For the nine months, Retail pretax income declined 17.5% to $913 million and Employer Group pretax income declined 22.3% to $328 million. Healthcare Services pretax income increased 51.7% to $593 million, supported by pharmacy and home-based services growth.
- The non-deductible health insurance industry fee increased the nine-month effective tax rate by approximately 10 percentage points. Humana paid $562 million for the 2014 fee; the industry-wide fee is scheduled to rise 41% in 2015.
Outlook, management commentary, risks and unusual items
- Management expected full-year 2014 operating cash flow to decline from 2013. It forecast 2014 capital expenditures, excluding acquisitions, of approximately $500–$525 million.
- Management estimated 2015 Medicare Advantage funding cuts of approximately 2%, considering benchmark changes and related factors. It said competitive product design and execution would be important; failure to adapt could materially affect results.
- Management expected group ASO commercial medical membership to decline approximately 400,000–425,000 members effective January 1, 2015, primarily due to the loss of several large accounts.
- Health reform risk-adjustment, risk-corridor, and reinsurance activity produced a net receivable of approximately $456 million at September 30, expected to settle in 2015. Medicare Part D subsidy receivables were $1.5 billion; claims payments exceeded related CMS receipts by $761 million during the nine-month period, with settlement expected in 2015.
- In September, Humana issued $1.75 billion principal amount of senior notes, generating net proceeds of $1.73 billion. In October it redeemed $500 million of 6.45% notes for approximately $560 million and recorded a $37 million extinguishment loss after quarter-end. The company also announced plans to repurchase $1 billion of shares by June 30, 2015, within a new $2 billion authorization.
- Risks include Medicare Advantage rate and Star Rating changes, provider disputes over sequestration-related payment reductions, evolving health reform rules and collections, and potential CMS risk-adjustment data validation (RADV) audit settlements. Humana said its current RADV estimates were not material but could not determine whether audits would have a material adverse effect.
- Legal and regulatory matters include pending Florida qui tam litigation and continuing government information requests. The filing states that losses beyond any accrued amounts cannot currently be estimated; outcomes could be material. No changes were reported to the risk factors in the 2013 Form 10-K.
Most important facts for investors to verify
- Whether 2015 Medicare Advantage rates, quality bonuses, and Star Ratings support the company’s expected membership, benefits, and margins.
- Actual Hepatitis C drug costs, medical utilization, and subsequent claims-reserve development; nine-month results included $440 million of favorable prior-period reserve development.
- Timing and collectability of the 3R and Medicare Part D receivables, including any government funding or settlement changes.
- Execution of the planned share repurchases and the effect of higher debt and the post-quarter debt redemption on liquidity and interest expense.
- Developments in RADV audits, Florida litigation, and other regulatory matters, for which the filing provides no clear estimate of potential losses beyond recorded accruals.