Anthem, Inc. (now Elevance Health) — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. The filing is by Anthem, Inc.; it reported 39.75 million medical members at quarter-end and operated Commercial and Specialty, Government, and Other segments.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Operating revenue | $21.27bn | $19.76bn | $41.58bn | $38.61bn |
| Total revenue | $21.46bn | $20.02bn | $41.74bn | $39.07bn |
| Net income | $780.6m | $859.1m | $1.48bn | $1.72bn |
| Diluted EPS | $2.91 | $3.13 | $5.54 | $6.22 |
| Benefit expense ratio | 84.2% | 82.1% | 83.1% | 81.2% |
| SG&A ratio | 14.0% | 15.4% | 14.8% | 16.0% |
- Operating revenue rose 7.7% in both Q2 and the first half, mainly on premium growth, rate increases, Medicaid membership growth, and higher self-funded administrative fees.
- Net income fell 9.1% in Q2 and 14.0% for the first half. Management cited weaker Government segment results, investment losses and impairments, Cigna-related costs, and higher interest expense. The first-half result also reflected net realized investment losses of $112.6m, versus gains of $138.8m a year earlier.
- Benefit expense increased 10.5% in Q2 and 10.3% in the first half, faster than revenue; the benefit ratio worsened 210 basis points in Q2 and 190 basis points for the first half. Higher Medicaid and Individual medical costs were important contributors. SG&A expense declined slightly, and its ratio improved.
- Segment results diverged: first-half Commercial and Specialty operating gain rose 8.7% to $2.37bn, while Government operating gain declined 17.0% to $775.5m. Government’s margin fell to 3.5% from 4.7%, largely as Medicaid medical costs outpaced rate increases.
- First-half operating cash flow was $1.97bn, down from $2.82bn. Cash and cash equivalents were $1.58bn at June 30, down $530.8m from year-end. Cash, cash equivalents, and investments totaled $24.43bn; $2.15bn of cash and investments was held at the parent company.
- At June 30, total debt-to-capital was 39.1%, compared with 40.8% at December 31, 2015. The balance sheet reported $14.20bn of long-term debt, $927.9m current portion of long-term debt, and $440m short-term borrowings. The $3.5bn revolving credit facility had no borrowings outstanding.
- Shareholders’ equity was $24.23bn and total assets were $64.06bn. The quarterly dividend was $0.65 per share; no shares were repurchased under the authorization during the first half.
Outlook, material developments, and risks
- Management considered a 2016 cost-of-care trend estimate of 7.0%–7.5% appropriate for its Local Group fully insured business. It reported outpatient and professional utilization broadly consistent with prior periods, lower inpatient and pharmacy utilization, and provider rate increases and high-cost Hepatitis C therapies as cost pressures.
- The proposed approximately $53bn Cigna acquisition remained pending. On July 21, 2016, after quarter-end, the U.S. Department of Justice and certain state attorneys general sued to block it. Anthem said it would defend the transaction. If completed, the company expected debt-to-capital of about 49%, with a goal of reducing it to the low 40% range about 24 months after closing; the filing does not provide a clear standalone full-year earnings forecast.
- If the merger is terminated because required regulatory approvals cannot be obtained, certain conditions could require Anthem to pay Cigna a $1.85bn termination fee. The merger agreement set a January 31, 2017 closing deadline, extendable to April 30, 2017 in specified circumstances.
- Anthem’s Express Scripts dispute involved claims of excessive pharmacy pricing and operational breaches; Express Scripts disputed Anthem’s claims and asserted counterclaims. A separate putative ERISA class action concerning prescription drug pricing was also filed in June 2016. Outcomes were uncertain.
- The company continued to face litigation and investigations related to its 2015 cyber attack, which exposed personal information. It said it could not reasonably estimate a possible loss range. For other specified legal proceedings, estimated reasonably possible losses in excess of established reserves ranged from $0 to approximately $250m.
- Other exposures included health-care cost and utilization trends, Medicaid and Medicare funding and compliance, health reform and related fees, investment-market risk, credit-rating pressure, and possible state guaranty-fund assessments tied to Penn Treaty. Management said regulated subsidiaries exceeded mandatory risk-based capital thresholds based on the latest reported year-end data.
Important facts for investors to verify
- Whether Government segment medical costs and benefit ratios improved relative to premium rate increases, especially in Medicaid and Individual business.
- Medical claims reserve development: Anthem recognized $726.3m of favorable prior-year claims reserve development in the first half; claims reserve estimates depend on trend and completion assumptions.
- The status and potential financial consequences of the Cigna antitrust case, financing commitments, termination provisions, and expected post-close leverage.
- Operating cash flow and liquidity trends, including the timing of claims payments, Medicaid receipts, and health reform reinsurance recoveries.
- Developments in the Express Scripts litigation and cyber-attack claims and investigations, for which potential losses were not clearly estimable.