Business context and reporting period
Humana Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. Its businesses are reported in Retail, Group, and Healthcare Services, with prior-period segment figures recast for a 2015 realignment. Medicare represented approximately 72% of premiums and services revenue for the nine-month period.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $13.36 billion | $12.24 billion | $40.93 billion | $36.17 billion |
| Operating income | $695 million | $589 million | $2.06 billion | $1.99 billion |
| Net income | $314 million | $290 million | $1.18 billion | $1.00 billion |
| Diluted EPS | $2.09 | $1.85 | $7.77 | $6.39 |
| Benefit ratio | 83.9% | 83.3% | 84.0% | 82.9% |
| Operating cost ratio | 12.8% | 15.6% | 13.4% | 15.4% |
Nine-month 2015 results include a $267 million pretax gain on the sale of Concentra ($1.53 per diluted share after tax). Concentra generated $411 million in revenue and $15 million in pretax income before its June 1 sale. Merger-related costs were $11 million for the nine months. Q3 results include neither Concentra’s operations nor the sale gain.
Operating cash flow was $531 million for the nine months, versus $1.43 billion in 2014; investing activities provided $617 million and financing activities used $1.49 billion. Cash and equivalents were $1.60 billion at September 30, down from $1.94 billion at year-end 2014. Investment securities totaled $9.30 billion. Long-term debt was $3.82 billion, with $11 million of commercial paper outstanding. The company had $999 million of available capacity on its $1.0 billion revolver and reported compliance with its credit covenants.
Total assets were $24.30 billion and total liabilities $13.94 billion at September 30, 2015. The nine-month effective tax rate was 46.2%; Q3’s was 51.5%. The company reported $1.09 billion of comprehensive income for the nine months.
Material changes versus prior comparable periods
- Nine-month revenue rose 13.1%, led by 15.1% growth in premiums, primarily from Retail membership growth. Q3 revenue rose 9.2%.
- Benefits expense rose 16.7% for the nine months, faster than premiums; the benefit ratio increased 110 basis points. Higher-than-priced medical costs and lower favorable prior-period claims reserve development contributed.
- Retail pretax income fell 13.9% to $960 million for the nine months, while Group pretax income rose 34.9% to $236 million and Healthcare Services pretax income rose 24.1% to $737 million.
- Operating cost ratios improved, partly reflecting efficiencies and Concentra’s sale. Investment income increased $60 million for the nine months, primarily from realized gains as the portfolio was repositioned. Interest expense increased $32 million, mainly reflecting higher average debt.
- Operating cash flow declined substantially, reflecting prior-year new-membership cash timing, lower earnings excluding the Concentra gain, and working-capital timing associated with pharmacy growth.
Outlook, management commentary, and risks
- Management expected average 2016 Medicare Advantage funding increases of approximately 0.8%, with local variation, and expected Medicare Advantage earnings improvement in 2016. It cautioned that claims recovery process changes could constrain earnings growth.
- Humana expected net individual Medicare Advantage membership growth in 2016 broadly in line with the market, excluding about 35,000 members from a Puerto Rico product discontinuance. It expected to lose about 145,000 group Medicare Advantage members when a large account moved to a private exchange.
- Individual commercial medical results were challenged by higher-than-expected member morbidity, utilization, and claims costs. For 2016, the company planned premium increases, product and market exits affecting about 100,000 members, and operational changes; it continued to evaluate its participation in this business for 2017.
- Management forecast a 2015 full-year effective tax rate of approximately 46.5%–47.5%, including the Concentra sale’s favorable effect, and 2015 capital expenditures of approximately $475–$525 million.
- The proposed Aetna merger would provide $125 cash and 0.8375 Aetna shares for each Humana share; estimated transaction value was approximately $37 billion, including assumed debt. Both companies’ shareholders approved relevant proposals on October 19, 2015. Regulatory and other closing conditions remained, and closing was expected in the second half of 2016. The agreement restricted dividends to $0.29 per quarter and suspended share repurchases.
- CMS notified insurers that 12.6% of 2014 risk-corridor receivables would be paid in December 2015–January 2016. Humana reported a $448 million gross risk-corridor receivable for 2014 and 2015 combined and noted uncertainty around ultimate program funding and timing. It also collected approximately $1.7 billion from CMS on October 30, 2015 for the 2014 Part D plan-year settlement.
- Risk exposures include CMS Medicare Advantage risk-adjustment audits and unresolved guidance on audit extrapolation; investigations and litigation concerning provider coding and risk-adjustment practices; and merger-related litigation, for which a settlement memorandum was subject to court approval. The filing stated that possible losses beyond accrued amounts could not be estimated and outcomes could be material.
- Investment portfolio sensitivity: management estimated a 1% increase in interest rates would reduce securities fair value by approximately $460 million. Most debt securities were investment grade; reported unrealized losses were considered temporary, but future realized or impairment losses remained possible.
Important facts for investors to verify
- Whether Medicare and individual commercial medical claims experience, pricing actions, and reserve development support the expected 2016 improvement.
- Actual timing and recovery of risk-adjustment, reinsurance, risk-corridor, and Part D receivables, and any resulting liquidity or statutory-capital effects.
- Progress and final conditions for Aetna merger regulatory approvals, including antitrust and state insurance approvals, and resolution of merger-related litigation.
- Outcomes of CMS risk-adjustment audits and government investigations, including any settlements, sanctions, or required changes to practices.
- Underlying operating cash generation, given its decline year over year, and the extent to which reported earnings depend on the Concentra sale gain and investment realizations.