Humana Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. Comparisons are with the three months ended March 31, 2019 unless otherwise noted. Humana operates Retail, Group and Specialty, and Healthcare Services segments, with Medicare products representing approximately 83% of premiums and services revenue.
Financial performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Total revenue | $18.935 billion | $16.107 billion | +17.6% |
| Premium revenue | $18.362 billion | $15.651 billion | +17.3% |
| Operating income | $1.074 billion | $847 million | +26.8% |
| Net income | $473 million | $566 million | -16.4% |
| Diluted EPS | $3.56 | $4.16 | -14.4% |
| Operating cash flow | $474 million | $896 million | -$422 million |
Revenue growth was led by Retail premiums, up 19.6%, primarily from Medicare Advantage and state-based contract growth. Healthcare Services revenue from external customers rose 44.2%, partly reflecting Enclara. Investment income increased 47.5% to $149 million, primarily due to higher realized capital gains.
Benefits expense increased 15.8% to $15.629 billion. The consolidated benefit ratio improved to 85.1% from 86.2%; the operating cost ratio rose to 11.3% from 10.4%. The effective tax rate increased to 34.8% from 24.4%, primarily due to the reinstated, nondeductible health insurance industry fee.
Net income and EPS were pressured by $297 million of net other expense, principally put/call option valuation adjustments associated with equity-method investments, versus $39 million of other expense in Q1 2019. Management said operating performance excluding those valuation adjustments improved, led by Retail and Healthcare Services, partly offset by lower Group and Specialty contribution. Favorable prior-period claims reserve development was $284 million consolidated, compared with $267 million a year earlier.
Segments and operating trends
- Retail: Segment earnings rose 47.3% to $685 million; premiums increased 19.6% to $16.704 billion. Individual Medicare Advantage membership grew 11.8% to 3.838 million. The benefit ratio improved to 86.6%, while the operating cost ratio increased to 9.2%. Stand-alone PDP membership declined 12.4% to 3.895 million.
- Group and Specialty: Segment earnings fell 36.4% to $105 million; premiums and services revenue decreased 1.3% to $1.853 billion. Fully insured commercial membership declined 10.1%; the benefit ratio increased to 79.1% and the operating cost ratio to 23.1%. Management attributed lower earnings principally to deliberate pricing and benefit-design changes following 2019 performance.
- Healthcare Services: Segment earnings rose 42.9% to $250 million. External services revenue was $225 million, up 44.2%, while intersegment revenue was $6.860 billion. Management cited pharmacy growth, provider-services improvements, and higher Kindred at Home investment earnings.
Cash, debt and liquidity
Cash and cash equivalents were $6.054 billion at March 31, 2020, versus $4.054 billion at year-end. Operating cash flow was $474 million; investing activities used $1.210 billion, including $709 million for Enclara and $192 million of capital expenditures; financing activities provided $2.736 billion, including proceeds from senior notes and a term loan. Management attributed the lower operating cash flow mainly to working-capital timing, including early prescription refills related to COVID-19.
Total short- and long-term debt was approximately $7.955 billion at quarter-end, versus $5.666 billion at December 31, 2019. The increase included $1.1 billion of senior notes issued in March and a $1.0 billion term-loan draw; commercial paper outstanding was $500 million. Humana reported no borrowings under its $2.0 billion revolving credit facility and stated it had $2.0 billion of remaining capacity. Debt-to-capitalization under the facility covenant was 39%, below the 50% maximum. Parent-company cash and short-term investments were $2.4 billion.
Management said available cash, investments, operating cash flow and financing capacity were adequate for at least the next 12 months. Regulated subsidiaries had $8.0 billion of statutory capital and surplus against $5.9 billion of minimum requirements; approximately $1.0 billion of ordinary dividends could be paid to the parent in 2020 without prior approval.
Outlook, significant events and risks
- COVID-19: In late March, Humana observed lower hospital admissions and utilization as nonessential procedures were deferred, alongside higher pharmacy costs from early refills and COVID-related administrative costs, including a $50 million Humana Foundation contribution. The net first-quarter impact was reported as not material. The company waived certain testing and treatment costs, expanded telehealth, and eased administrative requirements. Lower utilization persisted into Q2; management expected utilization to recover as deferred care resumed, but emphasized substantial uncertainty around pandemic duration, restrictions, testing, treatments and premium collections. The ultimate impact could be material.
- Medicare rates: Based on CMS’s April 6, 2020 Final Rate Notice, Humana estimated a 1.20% 2021 rate increase for non-ESRD Medicare Advantage, excluding EGWP funding changes, versus CMS’s 1.66% sector estimate on a comparable basis. It estimated a 3.7% increase for ESRD beneficiaries, compared with CMS’s 3.6% estimate.
- Health insurance industry fee: Humana expected to pay approximately $1.2 billion in September 2020 for the annual fee. The filing says the fee is permanently repealed beginning in 2021.
- Acquisitions and expansion: Humana acquired Enclara for approximately $709 million net of cash received. Its WCAS partnership planned to open approximately 50 senior-focused primary-care centers over three years beginning in 2020; Humana committed to acquire a noncontrolling interest in an approximately $600 million entity.
- Government and legal matters: Medicare risk-adjustment data audits, potential changes to CMS audit methodology, and related investigations could adversely affect results. Humana was seeking approximately $611 million in unpaid risk-corridor payments for 2014–2016 and had not recognized a receivable at March 31. On April 27, 2020, after quarter-end, the Supreme Court ruled that the government was obligated to pay risk-corridor losses; Humana said it would continue seeking payment. Other disclosed matters include DOJ information requests concerning Medicare risk-adjustment practices and False Claims Act litigation. The filing says outcomes and possible losses beyond accrued amounts could not be estimated and could be material.
- Investments and market risk: Approximately 96% of debt securities were investment grade, with an average S&P rating of AA. Unrealized investment losses were $171 million at March 31, primarily attributed to market-rate movements; management reported no material credit allowances. A 1 percentage-point rise in interest rates was estimated to reduce securities fair value by approximately $335 million.
Investor verification priorities
- Reconcile the $297 million put/call valuation expense and its effect on reported versus underlying earnings; review the assumptions used in valuing the options.
- Track COVID-19 utilization, deferred-care rebound, pharmacy costs, benefit costs, provider support and commercial premium collections against management’s uncertain outlook.
- Monitor Medicare Advantage risk-adjustment data submissions, CMS/RADV methodology and related audits, investigations and litigation.
- Verify the timing and amount of the expected $1.2 billion health insurance industry fee payment and its effects on cash flow, expenses and taxes.
- Assess debt growth, refinancing needs, credit availability, statutory dividend restrictions and cash conversion, including the working-capital impact of Medicare and prescription-drug settlements.
- Follow the final Enclara purchase-price allocation, WCAS partnership commitments, and any recognition or collection of the risk-corridor payments after the quarter-end court ruling.