Humana Inc. — 2010 Q3 Form 10-Q
Business context and period. This unaudited filing covers the quarter and nine months ended September 30, 2010, compared with the same 2009 periods. Humana operates Government and Commercial segments. At quarter-end it had 10.12 million medical members and 7.04 million specialty-product members.
Key financial results
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenue | $8.425bn | $7.717bn | $25.518bn | $23.327bn |
| Net income | $393.2m | $301.5m | $992.1m | $789.0m |
| Diluted EPS | $2.32 | $1.78 | $5.84 | $4.67 |
| Income before tax | $622.3m | $469.3m | $1.575bn | $1.203bn |
| Consolidated benefit ratio | 81.6% | 82.1% | 82.3% | 83.1% |
| Consolidated SG&A ratio | 12.9% | 13.7% | 13.3% | 13.5% |
| Operating cash flow | — | — | $2.289bn | $1.147bn |
Q3 revenue grew 9.2% and net income 30.4%; nine-month revenue rose 9.4% and net income 25.7%. Premium revenue was $8.135bn in Q3 and $24.673bn for the nine months. Government segment pretax income was $554.1m for Q3 and $1.362bn year to date; Commercial segment pretax income was $68.1m and $213.4m, respectively.
Balance sheet and liquidity. At September 30, cash and cash equivalents were $2.923bn, current investment securities $7.142bn, long-term investment securities $1.477bn, and total assets $16.390bn. Long-term debt was $1.671bn; total liabilities were $9.451bn. The company reported no borrowings under its $1.0bn revolving credit facility and $996.5m of remaining borrowing capacity. Management said available cash, investments, operating cash flow, and financing resources should cover operating and regulatory needs, capital spending, and debt obligations for at least 12 months. Nine-month capital expenditures were $152.4m; full-year 2010 capital expenditures, excluding acquisitions, were expected to be about $205m.
Material changes and drivers
- Government premium revenue increased 13.0% year to date, mainly on Medicare Advantage membership growth. Fully insured Medicare Advantage membership increased 14.6% year over year to 1.736 million.
- Commercial premium revenue declined 2.3% year to date, primarily because fully insured membership fell 10.2% to 1.671 million, reflecting pricing discipline. Commercial pretax income improved, supported by lower utilization, pricing, and administrative cost controls.
- Commercial fully insured medical membership fell 10.2%, and commercial ASO membership fell 6.8%; the latter included the loss of a large group account effective July 1, 2010. Stand-alone Medicare PDP membership declined 8.9% year over year.
- Operating cash flow more than doubled year over year. Management attributed the increase to earnings growth, enrollment activity, and working-capital movements, including higher benefits payable.
- During the first nine months, Humana repurchased 1.99 million shares for $100m under its $250m authorization. The remaining authorization was about $150m as of November 1, 2010.
Outlook, commentary, risks, and unusual items
- Health reform: The filing says the effects of the 2010 health reform legislation were not yet fully determinable. Minimum medical-loss ratios, Medicare Advantage payment changes, new taxes and fees, and restrictions on pricing and benefits could affect revenue, costs, and profitability. Humana recorded a $147.5m second-quarter write-down of deferred acquisition costs for individual major medical policies, citing expected effects of reform, including the 80% minimum benefit ratio requirement. The charge reduced nine-month diluted EPS by about $0.55.
- Reserve development: Favorable prior-year reserve releases not considered ordinary-course totaled about $55.9m in Q3 and $193.4m for the nine months, equal to approximately $0.21 and $0.72 per diluted share. Q3 also included about $27.7m, or $0.10 per diluted share, of favorable releases related to the first half of 2010. These releases boosted reported results and benefit ratios.
- Medicare audits: CMS was auditing selected Medicare Advantage contracts for provider coding and risk-adjustment data. Humana could not estimate potential effects; it warned that certain retroactive adjustment methodologies could materially adversely affect results, financial position, and cash flow.
- Government contracts: CMS renewed material Medicare contracts for 2011. Humana had been invited to negotiate a one-year TRICARE South extension through March 2012, but extension was not assured; it was also pursuing the next-generation contract award. Management noted a possible 2011 goodwill impairment if the current contract ends and Humana does not win the new award.
- Investments and market risk: The investment portfolio had an average S&P rating of AA and average duration of about 3.3 years including cash. Management estimated a 1 percentage-point increase in interest rates could reduce portfolio fair value by about $375m. Gross unrealized losses were $16.2m; the company reported no material other-than-temporary impairments for the period.
- Other contingencies: The filing describes provider litigation, ongoing regulatory reviews, and other lawsuits; outcomes cannot be predicted and could materially affect results. A shareholder derivative action was settled, including governance measures and $325,000 in plaintiffs’ attorneys’ fees. Management also reported that the OIG had indicated it would seek no additional materials under subpoenas concerning Medicare Part D and the mail-order pharmacy.
- Outlook: The filing provides no explicit earnings or revenue guidance. It announced a low-premium Humana Walmart-Preferred Rx Plan for the 2011 plan year and described 2011 Medicare Advantage payment rates as flat.
Investor verification points
- Assess how much of reported earnings growth depends on favorable reserve releases and the sustainability of recent utilization trends.
- Track implementation of health reform, including individual-policy economics, minimum medical-loss ratios, Medicare Advantage payments, and new taxes or fees.
- Monitor CMS risk-adjustment audits and any resulting methodology, contract-level extrapolation, or payment adjustments.
- Verify the TRICARE South extension and next-generation award outcome, and evaluate related goodwill and exit-cost exposure.
- Review commercial membership trends and pricing effects, as well as Medicare Advantage growth and the declining stand-alone PDP membership.
- Reconcile cash-flow growth with working-capital movements, including benefits payable and Medicare Part D settlements; confirm the timing of the disclosed 2009 contract-year settlements.