Humana Inc. 2016 Q2 Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2016. Financial statements are unaudited. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Total revenue | $14,007 | $13,732 | $27,807 | $27,565 |
| Operating income | $683 | $573 | $1,230 | $1,363 |
| Net income | $311 | $431 | $565 | $861 |
| Diluted EPS | $2.06 | $2.85 | $3.75 | $5.67 |
| Benefit ratio | 84.3% | 85.2% | 84.6% | 84.1% |
| Operating cost ratio | 12.4% | 13.3% | 12.7% | 13.8% |
- Premium revenue increased 3.3% in Q2 and 2.4% in the first half, primarily reflecting Retail growth. Services revenue declined, largely because Concentra was sold in June 2015.
- Q2 net income fell 27.8%; first-half net income fell 34.4%. Comparisons include the $267 million pretax Concentra sale gain in 2015 and a $208 million increase in the 2016 premium deficiency reserve (PDR) during Q2.
- Benefits expense rose 2.3% in Q2 and 2.9% in the first half. The Q2 benefit ratio improved year over year, while the first-half ratio worsened. Favorable prior-period claims development benefited 2016 results; the first-half comparison also reflects the PDR and an extra claims day from leap year.
- Operating costs declined 5.0% in Q2 and 7.1% in the first half, partly reflecting Concentra’s sale. The effective tax rate was 51.1% in Q2 and 50.3% in the first half, versus 45.6% and 44.0%, respectively, in 2015; the 2015 Concentra gain reduced that period’s rate.
- First-half operating cash flow was $206 million, versus cash used of $501 million in 2015. Management attributed the improvement principally to working-capital timing and higher earnings excluding the Concentra gain and PDR increase. Cash and cash equivalents were $2,429 million at June 30, down from $2,571 million at year-end.
Balance sheet, debt and liquidity
- Total assets were $27,236 million and stockholders’ equity was $10,874 million at June 30, 2016.
- Long-term debt was $3,793 million; short-term borrowings, consisting of commercial paper, were $300 million. Humana had no borrowings under its $1.0 billion revolving credit facility and reported $1.0 billion of available capacity.
- Humana reported covenant net worth of $10.9 billion against a $8.8 billion minimum and leverage of 1.5:1 against a 3.0:1 maximum. Management said available cash, investments, operating cash flow and financing capacity were adequate for at least the next 12 months.
- The investment portfolio’s net unrealized gain was $379 million at June 30. Management reported approximately 98% of debt securities were investment grade; a 1% increase in interest rates was estimated to reduce securities’ fair value by approximately $483 million.
Business developments, outlook and risks
- Individual commercial medical: Humana increased the 2016 coverage-year PDR by $208 million in Q2, bringing the balance to $337 million. Management cited unfavorable current and projected claims experience. It planned to offer on-exchange coverage in 11 states in 2017, discontinue substantially all compliant off-exchange plans, and reduce presence to no more than 156 counties from 1,351 in 2016. Expected 2017 premiums were $750 million to $1 billion, versus approximately $3.4 billion projected for full-year 2016; 2017 plans remained subject to regulatory approval.
- Medicare outlook: Humana estimated its 2017 Medicare Advantage funding would decline approximately 1.3% on average, with geographic results varying. The estimate excluded the benefit of the one-year 2017 suspension of the health insurer fee. Management estimated a 2016 effective tax rate of approximately 49%–51%, excluding merger transaction costs incurred after June 30; it expected the 2017 fee suspension to materially reduce operating costs and the effective tax rate.
- Aetna merger: The proposed merger consideration was 0.8375 Aetna shares plus $125 cash per Humana share. The parties extended the merger end date to December 31, 2016. On July 21, 2016, the DOJ and several state authorities sued to block the deal; Humana and Aetna said they would defend it. On August 2, they agreed to sell certain Medicare Advantage assets to Molina for approximately $117 million in aggregate. The merger and asset sales remained subject to litigation outcomes, regulatory approvals and other conditions; closing timing was uncertain.
- Other exposures: Humana disclosed CMS Medicare Advantage risk-adjustment audits, including five contracts selected for 2013 audits, and could not determine whether the audits might have a material adverse effect. It also described DOJ and qui tam inquiries involving risk-adjustment practices, other legal and regulatory matters, and uncertainty over collection of ACA risk-corridor receivables. The estimated 2016 health insurer fee was $912 million and was nondeductible for tax purposes.
Most important facts for investors to verify
- Whether claims experience and subsequent estimates require further changes to the $337 million PDR, and the financial impact of the planned 2017 individual-market contraction.
- Medicare Advantage rate changes, final approved 2017 plans, and actual membership, utilization and claims trends.
- Developments and timing in the DOJ merger litigation, Molina divestiture conditions, and whether the merger ultimately closes.
- Cash conversion and working-capital trends, including collection of Medicare and ACA receivables and payment of the $912 million health insurer fee.
- Outcomes of CMS risk-adjustment audits and related investigations, and any resulting financial, regulatory or reputational effects.