Humana Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results; dollar amounts are in millions unless stated otherwise. Humana’s business is principally Medicare-focused health insurance, alongside employer and specialty coverage and healthcare services.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $14,259 | $13,534 | $28,538 | $27,296 |
| Operating income | $862 | $1,100 | $1,622 | $2,838 |
| Income before taxes | $19 | $1,042 | $726 | $2,731 |
| Net income | $193 | $650 | $684 | $1,765 |
| Diluted EPS | $1.39 | $4.46 | $4.93 | $11.98 |
| Operating cash flow | — | $3,561 | $4,099 |
- Revenue increased 5.4% in Q2 and 4.6% for the first half. Premium growth, led by Medicare Advantage, and higher services and investment income contributed.
- Q2 benefit ratio was 84.1%, up 1.6 percentage points year over year; first-half ratio was 84.3%, up 0.8 points. Operating cost ratio was 12.5% in Q2 and 12.4% for the first half, respectively 1.7 and 1.3 points higher year over year.
- Benefits expense was $11,536 in Q2 and $23,206 for the first half. Interest expense was $53 and $106, respectively. The first-half effective tax rate was 5.8%, versus 35.4% in 2017.
- At June 30, cash and cash equivalents on the balance sheet were $8,052; the cash-flow statement reports $8,831 including $779 classified as held-for-sale. Investment securities were $9,843. Total debt was approximately $5,171, including $398 of commercial paper and $4,773 of long-term debt. A $2.0 billion revolving credit facility was undrawn.
- Total assets were $34,270 and stockholders’ equity $10,211. The company reported $3,561 of operating cash flow, $287 of net cash used in investing, and $1,515 of net cash provided by financing for the first half.
Material changes and notable items
- Humana recognized a $790 pretax loss on the expected sale of KMG America, classified as held-for-sale. A $430 deferred tax benefit partly offset the loss; KMG’s sale was expected in Q3 2018. The reported Q2 tax benefit was $174.
- Comparisons are affected by the $947 net Aetna merger termination gain recorded in the first half of 2017, including the breakup fee, and by the 2018 KMG loss. Other year-over-year factors include the 2017 suspension and 2018 reinstatement of the health insurer fee, the 2018 exit from individual commercial medical insurance, and the 2017 Penn Treaty guaranty assessment.
- First-half 2018 Medicare Advantage and Part D premiums made up approximately 80% of total premiums and services revenue. Individual Medicare Advantage membership rose 6.6% year over year to 3.03 million; stand-alone Part D membership declined 4.4% to 5.01 million.
- First-half operating cash flow included $3.3 billion of Medicare premium remittances received early because July payment dates fell on a weekend. Cash flow also reflected working-capital movements and approximately $230 million transferred in connection with KMG-related reinsurance.
Outlook, management commentary and risks
- Management said it expects adequate liquidity from cash, investments, operating cash flow and available borrowing capacity to meet operating needs, acquisitions and other obligations for at least the next 12 months.
- Humana expected to fund approximately $200 million of parent-company cash, plus transfer approximately $150 million of statutory capital, in connection with the anticipated KMG sale. It completed a 40% minority investment in Kindred at Home on July 2 and a 40% minority investment in Curo on July 11, for combined cash consideration of approximately $1.1 billion.
- Management’s strategy emphasizes integrated, physician-directed care and value-based arrangements. At June 30, approximately 65.4% of individual Medicare Advantage members were in value-based relationships. Humana anticipated a 2019 individual Medicare Advantage rate increase slightly below CMS’s sector estimate, excluding specified funding and quality-bonus changes.
- Key exposures include Medicare risk-adjustment data and CMS audits, the transition from RAPS to encounter-data-based risk scoring, regulatory and contract changes, and litigation or investigations. The company is seeking approximately $611 million in unpaid ACA risk-corridor payments; the case was stayed, and no receivable or revenue was recorded. Humana said potential outcomes of legal and regulatory matters could be material, but it could not estimate possible losses beyond recorded accruals.
- The approximately $1.04 billion 2018 health insurance industry fee was expected to be paid in September; the fee is nondeductible and is suspended under current law for 2019. Management also identified interest-rate exposure: a 1% increase in rates was estimated to reduce securities fair value by approximately $356 million. The investment portfolio’s net unrealized position moved from a gain of $198 million at year-end 2017 to a loss of $230 million at June 30, 2018.
Important facts for investors to verify
- Underlying earnings trends after separating the KMG disposal loss, the prior-year Aetna breakup gain, tax effects and other unusual items.
- Whether medical costs, favorable prior-period reserve development and the 2018 benefit design produce sustainable benefit ratios.
- Progress and final economics of the KMG sale, including funding needs, and integration and returns from the Kindred at Home, Curo, MCCI and FPG investments.
- CMS risk-adjustment and audit developments, the risk-corridor lawsuit, and any material change in legal or regulatory contingencies.
- Cash-flow quality and liquidity, distinguishing recurring cash generation from early Medicare receipts, held-for-sale cash and working-capital timing.