Business Context and Reporting Period
Company: Humana Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: Humana is a major health and supplemental benefits company operating in two segments: Government (Medicare, Military, Medicaid) and Commercial (employer groups and individuals). As of year-end 2008, the company served approximately 11.6 million medical members and 6.8 million specialty members. Government contracts accounted for 72% of total premiums and administrative services fees.
Key Financial Metrics
| Metric | 2008 | 2007 |
|---|---|---|
| Total Revenues | $28.95 billion | $25.29 billion |
| Net Income | $647.2 million | $833.7 million |
| Diluted EPS | $3.83 | $4.91 |
| Operating Cash Flow | $982.3 million | $1,224.3 million |
| Total Assets | $13.04 billion | $12.88 billion |
| Total Debt | $1.94 billion | $1.69 billion |
| Stockholders' Equity | $4.46 billion | $4.03 billion |
| Benefit Ratio | 84.5% | 83.0% |
| SG&A Expense Ratio | 13.7% | 13.9% |
Material Changes vs. Prior Period
- Earnings Decline: Net income decreased 22% to $647.2 million. This was primarily driven by lower operating earnings in the Government segment due to higher-than-expected prescription drug claims in stand-alone Medicare Part D plans and other-than-temporary investment impairments of $103.1 million (largely related to Lehman Brothers).
- Revenue Growth: Total revenues increased 14.6% to $28.95 billion. Government segment premiums rose 15.0% due to growth in Medicare Advantage membership (up 25.6%), while Commercial segment premiums grew 14.5% driven by specialty product acquisitions (CompBenefits and KMG).
- Membership Shifts: Medicare Advantage membership grew significantly, but stand-alone Medicare Part D membership declined by 10.9% as the company realigned premium and benefit structures to address higher pharmacy costs.
- Investment Portfolio: Gross unrealized losses on investment securities totaled $313.0 million at year-end, primarily due to widening credit spreads and interest rate increases. However, management deemed these losses temporary.
Guidance, Outlook, and Risks
- Outlook: Management expects Medicare Advantage membership to increase by 25,000 to 75,000 members in 2009. The consolidated SG&A expense ratio is expected to range between 13% and 14% for 2009, and the effective tax rate is projected between 34% and 35%.
- Regulatory Risks: The company faces significant exposure to federal government programs. CMS has announced audits of Medicare Advantage risk-adjustment data which could result in payment adjustments. Additionally, the Medicare Improvements for Patients and Providers Act of 2008 requires network-based plans for PFFS products by 2011.
- Contract Renewals: The TRICARE South Region contract (military services) was extended for an additional year through March 2010, with options for further extension. All material Medicare contracts were renewed for 2009.
- Legal Proceedings: The company is subject to securities class action litigation regarding 2008 earnings guidance and internal controls, as well as provider litigation regarding TRICARE reimbursement rates. Outcomes are uncertain and could materially affect results.
- Market Risk: Continued volatility in credit markets poses a risk to the investment portfolio and access to capital, though the company maintains adequate liquidity.
Investor Verification Checklist
- Medicare Part D Performance: Verify the accuracy of 2009 bid assumptions for stand-alone PDPs given the 2008 underperformance and membership decline.
- CMS Audit Exposure: Assess the potential financial impact of CMS risk-adjustment data validation audits on 2007 and 2008 premium revenues.
- Investment Impairments: Monitor the investment portfolio for further other-than-temporary impairments given the $313 million in unrealized losses and the $103 million realized loss in 2008.
- TRICARE Contract Status: Track the outcome of the nationwide TRICARE RFP process, as the loss of the South Region contract would be material.
- Legal Settlements: Review developments in the securities class action and provider litigation for potential liability estimates.