Humana Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; unaudited. Comparisons are with Q1 2014 unless otherwise stated. Amounts are in U.S. dollars.
Business context
Humana operates Retail, Group, and Healthcare Services segments, with most revenue from health insurance premiums. Effective January 1, 2015, it realigned certain businesses between segments and recast prior-period segment information. Medicare products generated approximately 72% of premiums and services revenue.
Financial results and key metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total revenue | $13.833 billion | $11.712 billion | +18.1% |
| Premium revenue | $13.248 billion | $11.083 billion | +19.5% |
| Operating income | $790 million | $721 million | +9.6% |
| Net income | $430 million | $368 million | +16.8% |
| Diluted EPS | $2.82 | $2.35 | +20.0% |
| Benefit ratio | 83.1% | 82.3% | +0.8 percentage points |
| Operating cost ratio | 14.2% | 15.4% | -1.2 percentage points |
| Effective tax rate | 42.2% | 46.4% | -4.2 percentage points |
Operating margin was approximately 5.7%, compared with 6.2% in Q1 2014. The benefit ratio measures benefits expense as a share of premiums; the operating cost ratio excludes depreciation and amortization and uses revenue less investment income as its denominator.
- Cash flow: Operating cash flow was $107 million, down from $671 million. Investing cash flow was an outflow of $94 million; financing cash flow was an outflow of $2 million. Cash and cash equivalents ended the quarter at $1.946 billion, versus $1.935 billion at year-end 2014.
- Balance sheet and liquidity: Total assets were $25.624 billion and total liabilities $15.580 billion. Current assets were $17.402 billion and current liabilities $9.177 billion. Long-term debt was $3.824 billion, essentially unchanged from year-end. Humana had $996 million of available capacity under its $1.0 billion revolving credit facility and no outstanding balance under that facility.
- Segment pretax income: Retail was $375 million (+1.6%); Group was $154 million (+6.9%); Healthcare Services was $230 million (+24.3%).
Material changes and drivers
- Revenue growth primarily reflected higher average Medicare Advantage and individual commercial medical membership. Individual Medicare Advantage membership increased 15.2% year over year; stand-alone Medicare Part D membership increased 13.6%; and individual commercial medical membership increased 50.9%.
- Net income growth also reflected a $53 million deferred tax asset recorded in connection with the Concentra sale classification, equivalent to approximately $0.35 per diluted share. Excluding that benefit, management attributed growth mainly to membership gains, partly offset by lower favorable prior-period medical claims reserve development.
- Favorable prior-period claims reserve development was $194 million, compared with $297 million a year earlier. Management cited improved initial claim-payment accuracy and higher-than-expected flu costs in Q4 2014 as factors in the decline.
- Benefits expense rose 20.6%, faster than premiums, and the consolidated benefit ratio worsened 0.8 percentage points. Operating costs rose 9.0%, but the operating cost ratio improved, principally reflecting Group segment cost-ratio improvement and efficiencies.
- Services revenue declined 8.9%, primarily due to the loss of large group administrative-services-only accounts amid disciplined pricing. Interest expense increased to $46 million from $35 million, reflecting higher average debt after 2014 note issuance.
- Operating cash flow fell substantially as working-capital movements—including receivables, other assets and the slower growth in benefits payable—more than offset higher earnings. Receivables increased to $1.690 billion from $1.053 billion at year-end.
Outlook, risks and unusual items
- Concentra sale: Humana agreed to sell the subsidiary for approximately $1.055 billion cash, subject to customary adjustments, regulatory clearance and closing conditions; closing was expected in Q2 2015. Management anticipated a gain of approximately $1.00–$1.10 per diluted share, subject to selling costs, changes in carrying values and taxes. Concentra reported Q1 revenue of $246 million and pretax income of $7 million.
- Management outlook: Management expected a full-year 2015 effective tax rate of approximately 46%–47%, capital expenditures of $525–$575 million, and payment of an $882 million non-deductible health insurance industry fee in September 2015. The filing states that available cash, investments, operating cash flows and financing capacity were expected to fund requirements for at least the next 12 months.
- Medicare rates: Based on CMS’s April 2015 final rate notice and other funding changes, Humana estimated average 2016 Medicare Advantage funding increases of approximately 0.8%; geographic results could vary and member benefits could be adversely affected in some markets.
- Regulatory and legal exposure: CMS risk-adjustment data validation audits of certain 2011 Medicare Advantage contracts were ongoing, and Humana said it could not determine whether the audits would have a material adverse effect. The company also described a Department of Justice information request concerning Medicare risk-adjustment practices, related Florida litigation, and other regulatory reviews and lawsuits. Potential losses beyond accruals could not be estimated clearly.
- Health reform and cash timing: The annual industry fee was expected to rise from $562 million in 2014 to $882 million in 2015. The net receivable associated with the ACA risk adjustment, risk corridor and reinsurance programs was approximately $732 million at quarter-end; collection timing and federal action could affect liquidity.
- Investment and financing risks: Approximately 97% of debt securities were investment grade. A 1 percentage point increase in interest rates was estimated to reduce the fair value of the investment portfolio, including cash equivalents, by approximately $471 million. Humana reported compliance with credit covenants; actual leverage ratio was 1.3:1 versus a maximum of 3.0:1.
- The Board declared a Q2 2015 dividend of $0.29 per share. Share repurchases continued under a $2 billion authorization; remaining authorization was $1.23 billion as of April 28, 2015.
Important facts for investors to verify
- Whether the Concentra transaction closed on the expected terms and how the final after-tax gain compared with management’s estimate.
- Whether growth in Medicare, commercial and Medicaid membership translated into sustainable margins, given the higher benefit ratio and reduced claims reserve releases.
- Collection and settlement timing for the $732 million ACA-program receivable and the $1.5 billion net Medicare Part D subsidy and discount asset.
- Developments in CMS risk-adjustment audits, DOJ inquiries and related litigation, including any quantified exposure or new accruals.
- Actual impact of the 2015 health insurance industry fee, 2016 Medicare Advantage funding and related product or benefit changes on earnings and cash flow.
- Cash generation and balance-sheet capacity after capital expenditures, dividends and planned share repurchases.