HUMANA INC annual report, FY2012

Humana Inc. 2012 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2012. The filing is an annual report, not a standalone fourth-quarter filing; quarterly results are noted below. Humana provides health insurance and health and wellness services through Retail, Employer Group, Health and Well-Being Services, and Other Businesses. At year-end it served 12.1 million medical members and 8.1 million specialty members. Federal government contracts generated approximately 75% of premiums and services revenue; Medicare products represented approximately 72%.

Financial performance and position

Metric	2012	2011	Change
Total revenue	$39.126 billion	$36.832 billion	Up 6.2%
Premiums revenue	$37.009 billion	$35.106 billion	Up 5.4%
Services revenue	$1.726 billion	$1.360 billion	Up 26.9%
Operating income	$2.016 billion	$2.344 billion	Down 14.0%
Income before taxes	$1.911 billion	$2.235 billion	Down 14.5%
Net income	$1.222 billion	$1.419 billion	Down 13.9%
Diluted EPS	$7.47	$8.46	Down 11.7%
Benefit ratio	83.7%	82.1%	Up 1.6 percentage points
Operating cost ratio	15.1%	14.8%	Up 0.3 percentage points
Operating cash flow	$1.923 billion	$2.079 billion	Down $156 million

Revenue growth reflected higher average Medicare Advantage membership and growth in Employer Group business. The lower net income primarily reflected weaker Retail segment results: Retail pretax income fell 26.8% to $1.162 billion as its benefit ratio rose to 84.1% from 81.2%. Employer Group pretax income increased 4.5% to $253 million, while Health and Well-Being Services pretax income rose 37.7% to $486 million. Other Businesses recorded a $19 million pretax loss, versus $84 million income in 2011.

Favorable prior-year medical claims reserve development was $257 million, down from $372 million in 2011, weighing on year-over-year benefit-ratio comparisons. The filing attributes the Retail ratio increase principally to planned positioning for health reform funding and minimum-ratio requirements, higher costs on new Medicare Advantage membership than bid assumptions, and increased outpatient utilization.

Fourth-quarter context: 2012 Q4 revenue was $9.557 billion, pretax income $282 million, net income $192 million, and diluted EPS $1.19. In 2011 Q4, these were $9.056 billion, $313 million, $199 million, and $1.20, respectively.

Liquidity, debt and capital allocation

• Cash and cash equivalents were $1.306 billion at year-end, compared with $1.377 billion; total cash and investments were $11.153 billion, versus $10.830 billion.
• Total assets were $19.979 billion; stockholders’ equity was $8.847 billion. Long-term debt was $2.611 billion, up from $1.659 billion, mainly following the issuance of $1.0 billion of senior notes in December 2012.
• The notes issued were $600 million of 3.15% notes due 2022 and $400 million of 4.625% notes due 2042. Proceeds principally funded the Metropolitan acquisition and repayment of its debt. Interest expense was $105 million.
• Humana reported $995 million of remaining availability under its $1.0 billion revolving credit agreement, with no borrowings outstanding. It reported compliance with covenants and a 1.1:1 leverage ratio under the agreement.
• Investing cash outflow was $1.965 billion, including $1.235 billion of net acquisition spending and $410 million of capital expenditures. The company expected 2013 capital expenditures of approximately $425–$450 million, excluding acquisitions.
• Share repurchases were $460 million under authorizations, and dividends paid were $165 million. The remaining repurchase authorization was $640 million as of February 1, 2013.

Material changes, outlook and notable items

• TRICARE contract accounting changed: From April 1, 2012, the new South Region contract is accounted for similarly to an administrative-services-only arrangement, with the federal government retaining healthcare-cost risk. This materially reduced reported military premiums and benefits relative to the prior gross-revenue presentation and contributed to the 51.9% decline in Other Businesses premiums. The contract runs through March 2017, subject to annual government renewals; the government indicated its intent to extend through March 2014.
• Acquisitions expanded care delivery: Humana acquired Arcadian, adding about 62,600 Medicare Advantage members; SeniorBridge, a home-care provider; and Metropolitan, for a transaction value of $851 million. It also acquired a noncontrolling interest in MCCI. Metropolitan and MCCI coordinate care and accept financial risk under capitation arrangements. Humana divested about 12,600 Arcadian members effective January 1, 2013 under a Department of Justice agreement.
• Medicare Advantage rate outlook: CMS’s February 15, 2013 Advance Notice indicated, in Humana’s view, a preliminary mid-single-digit decline in 2014 benchmark rates, excluding industry premium tax, county rebasing, and risk-factor recalibration. Final rates were expected April 1, 2013. Management said it was evaluating operational responses; this was preliminary, not final guidance. The filing provides no clear companywide earnings or revenue forecast.
• Health reform exposures: Management identified uncertainty around Medicare payment rates, minimum medical-benefit ratios, exchanges, Medicaid expansion, and new taxes and assessments beginning in 2014. The company noted that additional regulation and implementation guidance remained outstanding.
• Medicare quality ratings: CMS ratings indicated 99% of Humana Medicare Advantage members were in plans expected to qualify for 2014 quality bonuses. Beginning in 2015, plans generally must have four or more stars to qualify for bonuses; future ratings and bonus eligibility are not assured.
• Contingencies and unusual expenses: Humana recorded a $46 million military-services litigation settlement expense in 2012 and $29 million of additional long-term-care benefits expense following a change in claims-duration experience. The closed long-term-care block carried $1.1 billion of future policy-benefit reserves. A Medicare Part D risk-corridor net payable was $356 million at year-end. RADV audit accrual estimates were not material, but the company said the potential effect of future CMS audits was not yet determinable.
• A Florida qui tam case alleging improper inducements was dismissed with prejudice; the court denied reconsideration, and Humana expected an appeal. Separately, federal authorities had requested documents and information concerning matters including medical-claim coding by certain South Florida providers and loans to physician practices. The filing states that outcomes of legal and regulatory matters cannot be predicted and may be material.
• Humana identified significant operating risks including medical-cost and reserve estimation, dependence on government programs and CMS contracts, provider relationships, regulatory change, acquisition integration, cybersecurity and data integrity, and access to subsidiary cash subject to insurance regulation. It reported effective disclosure controls and internal control over financial reporting; Metropolitan was excluded from management’s control assessment because it was acquired late in 2012.

Most important facts for investors to verify

• Whether subsequent Medicare Advantage rate notices and policy changes confirmed or altered the preliminary 2014 payment outlook, and their impact on margins, benefits, and enrollment.
• Whether Medicare Advantage medical costs, especially new-member utilization, and the benefit ratio stabilized after the 2012 deterioration; also assess earnings’ reliance on favorable reserve development.
• Whether CMS Part D risk-corridor settlements and RADV audits result in payments, revenue adjustments, or penalties beyond year-end estimates.
• Whether the Metropolitan, MCCI, and other acquisitions deliver expected integration and care-management benefits while managing provider-capitation risk.
• Whether liquidity remains adequate after acquisition spending, debt growth, capital expenditures, repurchases, and regulatory limits on dividends from insurance subsidiaries.
• How long-term-care claims experience, rate approvals, and reserve assumptions evolve, given the $1.1 billion closed-block liability and 2012 reserve increase.
• The progress and outcomes of the South Florida federal inquiry, the expected appeal of the dismissed qui tam case, and other material legal or regulatory matters.