Humana Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; filed August 1, 2012. Interim financial statements are unaudited. Humana provides health insurance and health and wellness services, with Retail, Employer Group, Health and Well-Being Services, and Other Businesses segments.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $9.699 billion | $9.284 billion | $19.918 billion | $18.475 billion |
| Operating income | $590 million | $754 million | $1.006 billion | $1.278 billion |
| Net income | $356 million | $460 million | $604 million | $775 million |
| Diluted EPS | $2.16 | $2.71 | $3.65 | $4.57 |
| Benefit ratio | 83.5% | 82.1% | 84.5% | 83.0% |
| Operating cost ratio | 14.4% | 13.0% | 14.0% | 13.4% |
Revenue increased 4.5% in Q2 and 7.8% year to date, but net income fell 22.6% and 22.1%, respectively. Management attributed the earnings decline mainly to weaker Retail and Other Businesses results, including higher benefit ratios and operating costs. Retail benefit ratios rose amid Medicare Advantage membership growth, increased utilization and quality-related spending, and positioning for health reform requirements. Q2 results also included a $46 million military-contract litigation settlement expense. Favorable prior-year claims reserve development partly offset expenses.
Cash flow and liquidity: First-half operating cash flow was $3.052 billion versus $957 million a year earlier; cash and equivalents were $3.869 billion at June 30, versus $1.377 billion at year-end 2011. The operating cash flow increase was materially affected by receipt in June of $2.133 billion in Medicare premiums for July, resulting in seven monthly Medicare payments in the period versus six in the prior-year period. Investing cash outflow was $339 million and financing cash outflow was $221 million. Management said cash, investments, operating cash flow and financing availability were adequate for at least the next 12 months.
Total assets were $20.855 billion, current assets $14.071 billion, and current liabilities $8.676 billion at June 30. Long-term debt was $1.618 billion, down from $1.659 billion at year-end. The $1.0 billion revolving credit facility had no borrowings and $989 million of remaining availability, including $11 million of letters of credit. Humana reported compliance with its covenants; its credit-agreement leverage ratio was 0.7:1. First-half capital expenditures were $185 million; management expected approximately $375 million for full-year 2012, excluding acquisitions.
Material changes and developments
- Individual Medicare Advantage membership rose 18.3% year over year to 1.896 million; individual stand-alone PDP membership grew 20.3% to 2.897 million. Arcadian, acquired effective March 31, added approximately 62,600 Medicare Advantage members. Humana expected to divest approximately 12,600 overlapping members effective January 1, 2013 under a DOJ consent agreement.
- The new five-year TRICARE South Region contract began April 1, 2012. Unlike the prior risk-sharing arrangement, the federal government retains health-benefit cost risk; Humana records administrative-service revenue net of estimated health costs rather than gross premiums and benefits. This change substantially reduced reported Other Businesses premiums compared with 2011.
- Health and Well-Being Services pretax income increased 48.9% in Q2 and 42.2% year to date, primarily on pharmacy growth and higher mail-order utilization. Employer Group pretax income was $114 million in Q2, up 5.6%, but first-half pretax income declined 4.9% to $235 million.
- Humana acquired SeniorBridge, an in-home chronic-care provider, on July 6, 2012. The company also reported a new $1 billion share-repurchase authorization, expiring June 30, 2014; $874 million remained as of July 31.
Outlook, risks and unusual items
- No specific company earnings or revenue guidance is stated in the supplied filing text. Management cited a 3.07% average increase in 2013 Medicare Advantage payment rates and said it believed it could design competitive products, while cautioning that execution and profitability were not assured. All material CMS contracts were renewed for 2013, with product offerings still subject to CMS approval expected in fall 2012.
- Health reform implementation, minimum medical-loss-ratio requirements, Medicare payment changes, and new fees and assessments—including a nondeductible annual insurer fee beginning in 2014—could affect pricing, benefits, membership, costs, taxes and cash flows. Regulatory interpretation and implementation remained uncertain.
- CMS risk-adjustment data validation audits may result in extrapolated settlements. Humana said it awaited further CMS guidance and could not determine whether audits would materially affect results, financial position or cash flows.
- Humana disclosed an ongoing internal investigation of certain Florida subsidiary practices, voluntarily reported to CMS, the DOJ and Florida regulators, and a related qui tam lawsuit alleging improper inducements and other conduct. The DOJ was also seeking information on certain South Florida matters. The company said outcomes and potential penalties could not be predicted; sanctions could be substantial.
- The Sacred Heart provider litigation was settled and dismissed during Q2, with approximately $46 million of additional benefit expense recorded. Management also noted that investment fair values remain exposed to interest-rate changes; a 1% rate increase was estimated to reduce portfolio fair value by approximately $431 million.
Important facts for investors to verify
- Whether elevated Retail and consolidated benefit ratios persist, especially for newer Medicare Advantage members, and how utilization and claims reserve development evolve.
- The recurring cash-generation level after excluding the early $2.133 billion Medicare remittance and other working-capital timing effects.
- CMS approval and 2013 economics for Medicare products, plus the impact of payment rates, quality bonuses and health reform requirements.
- Developments and potential financial consequences from RADV audits, the Florida investigation and related litigation or regulatory inquiries.
- Execution and financial contribution from Arcadian and SeniorBridge, including the required Arcadian divestitures.
- TRICARE contract performance and cash timing under the new administrative-services accounting arrangement.