Humana Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Financial statements are unaudited. Humana is a health and well-being company with substantial Medicare Advantage and Part D operations; Medicare products accounted for approximately 72% of premiums and services revenue in the first half of 2015.
Key financial metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $13.732 billion | $12.222 billion | $27.565 billion | $23.934 billion |
| Operating income | $573 million | $681 million | $1.363 billion | $1.402 billion |
| Net income | $431 million | $344 million | $861 million | $712 million |
| Diluted EPS | $2.85 | $2.19 | $5.67 | $4.54 |
| Benefit ratio | 85.2% | 83.1% | 84.1% | 82.7% |
| Operating cost ratio | 13.3% | 15.1% | 13.8% | 15.2% |
- Revenue growth was driven primarily by higher Retail premiums, including Medicare, Medicaid and individual commercial business. Benefits expense rose faster than premiums, lifting the benefit ratio and reducing operating income.
- Q2 pretax income included a $267 million gain on the Concentra sale; the company reported an after-tax gain of $1.53 per diluted share across the first half. Higher share repurchases also supported EPS comparisons.
- First-half operating cash flow was a use of $501 million, versus $471 million provided in the prior-year period. Investing activities provided $1.222 billion, including $1.055 billion in proceeds from the Concentra sale; financing activities used $406 million. Cash and cash equivalents were $2.250 billion at June 30.
- At June 30, total assets were $25.384 billion, total liabilities $15.301 billion, and stockholders’ equity $10.083 billion. Long-term debt was $3.823 billion and short-term commercial paper borrowings were $300 million. Humana had $999 million of unused capacity under its $1.0 billion revolving credit agreement and reported compliance with its debt covenants.
Material changes and management commentary
- Retail pretax income fell 35% in Q2 and 17.4% for the first half, primarily due to higher Medicare Advantage and individual commercial medical costs, changes in estimates for health reform risk-sharing programs, and a higher mix of state-based business. Individual Medicare Advantage membership grew 14.8% year over year; stand-alone Part D membership grew 14.3%.
- Management cited lower-than-expected Medicare Advantage claim recoveries and less-than-anticipated reductions in inpatient admissions. Certain individual commercial products, particularly ACA-compliant off-exchange plans, had claims above pricing assumptions. The company was evaluating 2016 pricing and participation in some products.
- Group pretax income increased 43.3% in Q2 and 13.2% for the first half, primarily from lower operating cost ratios, partly offset by higher benefit ratios and specialty drug costs. Healthcare Services pretax income increased 8.3% and 15.9%, respectively, supported by pharmacy and home-based services growth.
- Concentra was sold on June 1 for approximately $1.055 billion cash, excluding transaction costs. Its results are included through the sale date; the disposition reduced reported services revenue.
- Cash flow was affected by working-capital movements and growth in receivables. The net receivable associated with ACA risk adjustment, risk corridors and reinsurance was approximately $899 million at June 30. The company reported collecting $495 million of 2014 Medicare risk-adjustment payments in July and expected approximately $800 million of 2015 mid-year payments in August.
Outlook, risks and unusual items
- On July 2, 2015, after quarter-end, Humana agreed to be acquired by Aetna. Each Humana share is to receive $125 cash and 0.8375 Aetna shares; the transaction was valued at approximately $37 billion including assumed debt. Closing was expected in the second half of 2016, subject to shareholder, regulatory and other conditions.
- The merger agreement limits certain business actions and dividends to no more than $0.29 per share quarterly before closing. Humana suspended its share repurchase program after July 2. If specified termination conditions occur, Humana could owe Aetna a $1.314 billion termination fee. The fixed stock exchange ratio means the value of the stock consideration can fluctuate.
- Management expected a 2015 effective tax rate of approximately 46%–47%, including the favorable effect of the Concentra sale; 2015 capital expenditures were estimated at $475 million–$525 million. The company expected to pay an $866 million nondeductible health-insurance industry fee in September 2015, compared with $562 million in 2014.
- Management estimated average 2016 Medicare Advantage funding increases of approximately 0.8%, with geographic variation. It cautioned that product pricing, benefits and competitive position would depend on market-specific rates and execution.
- Risks include CMS audits of Medicare Advantage risk-adjustment data, uncertainty about the government’s audit methodology, potential changes to health reform programs and premium regulation, and the possibility that medical costs or member risk profiles differ from pricing assumptions. Legal matters include government inquiries and litigation concerning risk-adjustment practices, as well as lawsuits seeking to block the merger. The filing states potential losses beyond accrued amounts could not be estimated clearly and outcomes could be material.
- Humana’s investment portfolio was exposed to interest-rate risk; management estimated a 1 percentage-point rise in rates could reduce securities’ fair value by approximately $440 million. It considered reported unrealized losses temporary at June 30, but noted future realized losses or impairments remained possible.
Important facts for investors to verify
- Underlying earnings and Retail medical-cost trends excluding the Concentra gain, including later claims development and changes to 2016 pricing.
- Whether CMS settles risk-adjustment, risk-corridor and reinsurance balances as expected, and the timing and collectability of related receivables.
- Progress and conditions for the Aetna transaction, including regulatory approvals, litigation, merger-related restrictions and potential termination exposure.
- Liquidity and capital effects of the $866 million health-insurance fee, negative first-half operating cash flow, and any changes in debt, borrowing capacity or regulated-subsidiary dividend availability.
- Developments in CMS risk-adjustment audits and other legal or regulatory proceedings, including any quantified exposure disclosed in subsequent filings.