Business context and reporting period
This is WellPoint, Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2010, filed November 3, 2010. The filing identifies the registrant as WellPoint, Inc.; it is not filed under the name Elevance Health. WellPoint reported 33.5 million medical members and 70.4 million individuals served across its subsidiaries. Its reportable segments were Commercial, Consumer, and Other.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Operating revenue | $14.3 billion | $15.2 billion | $43.4 billion | $45.8 billion |
| Net income | $739.1 million | $730.2 million | $2.34 billion | $2.00 billion |
| Diluted EPS | $1.84 | $1.53 | $5.52 | $4.12 |
| Operating cash flow | Not separately stated | Not separately stated | $829.7 million | $3.01 billion |
- Margins and claims costs: Q3 benefit expense ratio was 83.8%, up 170 basis points year over year; SG&A ratio was 14.6%, down 30 basis points. Nine-month ratios were 82.8% and 14.9%, respectively. Net income margin was 5.1% for Q3 and 5.3% for the nine-month period.
- Adjusted earnings: Management’s non-GAAP adjusted net income was $701.2 million for Q3, down 18%; adjusted diluted EPS was $1.74, down 2%. For nine months, adjusted net income was $2.28 billion, down 5%, while adjusted diluted EPS was $5.38, up 10%. These measures exclude specified investment gains and losses, impairment charges, and other items.
- Balance sheet and liquidity: At September 30, cash and cash equivalents were $2.25 billion, total assets $51.0 billion, total liabilities $26.7 billion, and shareholders’ equity $24.4 billion. Long-term debt was $8.22 billion, with $706.5 million current portion and $100 million short-term borrowings. Cash, cash equivalents, and investments, including long-term investments, totaled $21.2 billion. The reported debt-to-total-capital ratio was 27.0%, versus 25.3% at year-end 2009.
- Cash flow: Operating cash flow fell to $829.7 million from $3.01 billion. The company attributed the decline chiefly to a $1.2 billion IRS tax payment related to the 2009 PBM sale, higher incentive compensation, claims runout related to membership transfers, and lower Medicare Part D low-income subsidy enrollment. Investing cash used was $1.17 billion and financing cash used was $2.23 billion.
Material changes versus the prior comparable period
- Q3 operating revenue declined 6% and nine-month revenue declined 5%, largely reflecting lower fully insured membership, conversions of large accounts to self-funded status, UniCare membership transfers to HCSC, the PBM business sale, and lower Part D LIS membership.
- Q3 GAAP net income rose 1%, but the comparison benefited from the absence of the $205.5 million 2009 intangible-asset impairment. Q3 adjusted EPS declined 2%, distinguishing underlying performance from reported EPS growth, which also benefited from a lower share count.
- Nine-month GAAP net income rose 17%, while adjusted net income fell 5%. The reported improvement reflected much lower investment impairment losses and higher realized investment gains, as well as Commercial performance and lower interest and amortization expense.
- Medical membership declined 1% to 33.5 million. Fully insured membership fell 11%, while self-funded membership increased 7%, in part because of account conversions. Commercial operating gain rose 21% in Q3; Consumer operating gain fell 50%; Other operating gain fell 87%, primarily following the PBM sale.
- WellPoint repurchased 58.9 million shares for $3.35 billion in the first nine months, versus 40.8 million shares for $1.81 billion in the prior-year period. Diluted weighted-average shares fell 16% in Q3 and 13% for the nine-month period.
Outlook, management commentary, risks and unusual items
- Management lowered its 2010 Local Group fully insured cost-of-care trend estimate to 7.0%, plus or minus 50 basis points, from 8.0%, citing a milder flu season, favorable prior-period trend restatement, and contracting efforts. Inpatient trend was low double digit; outpatient and physician trends were high- and mid-single digit, respectively.
- Management expected approximately $150 million of losses in the California individual market in 2010 because revised rate increases were expected not to cover costs. Results for 2011 and beyond were not estimable at filing date.
- Management expected more than $4.0 billion in share repurchases during 2010 and approximately $2.3 billion in ordinary subsidiary dividends. It said expected operating cash flow would be adversely affected by the $1.2 billion tax payment. These are forward-looking statements, not guarantees.
- Health care reform created material uncertainty, particularly minimum medical loss ratio rules expected to begin affecting certain businesses in 2011, future rate-setting constraints, new taxes and fees, and Medicare Advantage reimbursement reductions. Management said final regulatory details and the overall business impact remained uncertain.
- Medical claims payable was $4.96 billion. Management reported approximately $210 million of higher-than-anticipated favorable reserve releases in the first nine months, and disclosed that changes in completion-factor and trend assumptions could produce estimated variability of approximately $181 million and $328 million, respectively, in the unpaid claims liability.
- Investment impairment losses recognized in income were $29.0 million for nine months, versus $409.7 million in 2009. Management cautioned that further fair-value declines could lead to additional material impairment charges. The portfolio included $82.0 million of sub-prime and $257.9 million of Alt-A securities.
- Potential NOLHGA assessments associated with Penn Treaty’s possible liquidation could not be estimated and might be material. The filing also describes unresolved demutualization and out-of-network reimbursement litigation, among other proceedings; ultimate outcomes were generally undetermined.
- WellPoint issued $1.0 billion of notes in August 2010: $700 million at 4.350% due 2020 and $300 million at 5.800% due 2040. It entered a new $2.0 billion credit facility maturing in 2013, with no amount drawn at quarter-end; commercial paper outstanding was $391.1 million. Management cited commercial-paper market volatility and investment-grade rating sensitivity.
Important facts for investors to verify
- Confirm the registrant and security being analyzed: the filing is for WellPoint, Inc. in 2010, despite the request metadata naming Elevance Health.
- Review whether the decline in adjusted Q3 earnings, worsening Consumer results, and California individual-market losses persisted in later periods.
- Assess claims-reserve development and the assumptions behind the reported $704.8 million of prior-year redundancies and the disclosed estimation sensitivity.
- Track implementation and financial effects of health reform, especially medical loss ratio regulations, premium-rate approvals, and Medicare Advantage reimbursement.
- Evaluate cash conversion after the unusual tax payment, the scale of buybacks relative to operating cash flow, and debt, ratings, and commercial-paper refinancing capacity.
- Monitor litigation, potential Penn Treaty assessments, and investment portfolio impairment exposure.