Humana Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; filed August 1, 2011. Financial statements are unaudited. Humana is a health insurer and health-services provider, with Medicare representing approximately 65% of premiums and services revenue for the first half of 2011.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $9.284 billion | $8.589 billion | $18.475 billion | $16.970 billion |
| Net income | $460.3 million | $340.1 million | $775.5 million | $598.8 million |
| Diluted EPS | $2.71 | $2.00 | $4.57 | $3.52 |
| Operating income | $754.2 million | $562.1 million | $1.278 billion | $1.005 billion |
| Benefit ratio | 82.2% | 82.0% | 83.0% | 82.8% |
| Operating cost ratio | 13.0% | 12.9% | 13.4% | 12.8% |
- For the first half, premiums rose 6.5% to $17.616 billion; services revenue increased to $678.5 million, primarily reflecting the acquired Concentra business. Investment income was $180.7 million, up 9.4%.
- First-half benefits expense increased 6.8% to $14.615 billion, while operating costs rose 13.6% to $2.448 billion. The reported benefit ratio increased 20 basis points year over year. The operating cost ratio increased 60 basis points, partly reflecting a larger contribution from the higher-cost Health and Well-Being Services segment.
- Operating cash flow was $956.7 million in the first half, versus $1.080 billion in 2010. Investing activities used $858.8 million and financing activities used $203.1 million; cash decreased $105.3 million to $1.568 billion.
- At June 30, total assets were $17.595 billion, total liabilities $10.008 billion, and stockholders’ equity $7.587 billion. Long-term debt was $1.664 billion, broadly unchanged from year-end 2010. The $1.0 billion revolving credit facility had no borrowings and $988.4 million of remaining availability; the company reported compliance with its covenants.
Changes versus the prior comparable period
- Q2 revenue rose 8.1% and net income rose 35.3%; first-half revenue increased 8.9% and net income increased 29.5%. Management attributed improved earnings mainly to Retail, Health and Well-Being Services, and Employer Group results.
- Retail premiums grew 12.0% in Q2 and 11.8% for the first half, primarily from Medicare membership growth. Individual Medicare Advantage membership was 1.603 million, up 9.5% year over year; stand-alone Part D membership was 2.409 million, up 41.0%, helped by the Humana Walmart-Preferred Rx plan.
- Employer Group premiums fell 3.8% in Q2 and 3.7% for the first half, amid lower commercial medical membership. Fully insured and ASO medical membership declined 8.4% and 17.0%, respectively.
- Health and Well-Being Services pretax income increased 72.6% in Q2 and 85.8% for the first half, reflecting pharmacy growth and Concentra, acquired in December 2010. Other Businesses pretax income declined, principally because of lower income from the LI-NET contract.
- Reported earnings include favorable prior-period medical claims reserve development: $55.1 million in Q2 2011 and $116.8 million in the first half, compared with $117.0 million and $137.5 million in 2010. The 2010 comparison also includes a $147.5 million deferred acquisition cost write-down ($0.55 per diluted share), which did not recur.
- Effective January 2011, Humana realigned segments and reclassified certain pharmacy-related costs and revenues. Prior periods were conformed; the changes did not affect net income, cash flows, or equity.
Outlook, risks and unusual items
- No consolidated earnings or revenue guidance is stated in the supplied filing text. Management said it believed it could design competitive 2012 Medicare Advantage products based on the announced average sector-wide payment-rate increase of 0.4%, while pursuing cost reduction and care coordination; successful execution is not assured. Humana expected to learn the status of its 2012 product offerings in fall 2011.
- Health reform creates uncertainty around Medicare Advantage payment reductions, minimum medical-loss ratios and rebates, new taxes and assessments beginning in 2014, and other rulemaking. The company warns these changes could adversely affect pricing, enrollment, costs, earnings, financial position, and cash flows.
- CMS risk-adjustment data validation audits cover six Humana contracts for 2007. Humana disputes the proposed audit/payment-adjustment methodology and warns that implementation without changes could materially harm results. The filing does not provide a clear estimate of potential loss.
- The TRICARE South Region award to Humana was upheld by the GAO and the stop-work order was lifted, but a competing bidder’s Court of Federal Claims complaint remained pending. The company said the ultimate contract outcome remained subject to that case.
- Humana reported an ongoing internal investigation into aspects of its Florida operations, voluntarily disclosed to CMS, the U.S. Department of Justice, and Florida authorities. The filing says potential outcomes of investigations and litigation cannot be reliably predicted; sanctions could be substantial.
- Other exposures include provider litigation, regulatory reviews, and government-contract risks. The company also cited potential federal spending disruption if Congress failed to raise the debt ceiling. It reported no material impairment of investment securities in the period, but noted future fair-value declines or impairment remain possible.
- The board initiated a quarterly dividend of $0.25 per share and authorized up to $1 billion of share repurchases through June 30, 2013. The dividend was paid after quarter-end; approximately $799.9 million remained authorized as of August 1, 2011. Future dividends remain at board discretion.
- Management estimated 2011 capital expenditures, excluding acquisitions, at approximately $280 million. It stated cash, investments, operating cash flow, and available financing should be adequate for operating and regulatory needs for at least the next 12 months.
Important facts for investors to verify
- Whether earnings growth persists after accounting for favorable reserve development and the one-time 2010 acquisition-cost write-down.
- Medicare Advantage and Part D membership economics, medical utilization, benefit ratios, and the effect of 2012 payment rates and subsequent health-reform rules.
- CMS risk-adjustment audit developments and any resulting payment adjustment or reserve impact.
- The outcome of the TRICARE contract challenge and the Florida investigation, including any financial, operational, or regulatory consequences.
- Cash conversion and working-capital movements, including Medicare receivables, benefits payable, and CMS Part D settlements.
- Capital allocation under the repurchase authorization and dividend policy, alongside investment portfolio interest-rate exposure; the filing estimates a 1% rate increase could reduce securities fair value by approximately $410 million.