HUMANA INC quarterly report, Q3 FY2011

Humana Inc. — Q3 2011 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2011. The interim financial statements are unaudited. Humana is a health insurer and healthcare services company, with Retail, Employer Group, Health and Well-Being Services, and Other Businesses segments. Segment results were retrospectively recast following a 2011 realignment.

Financial performance and position

Metric	Q3 2011	Q3 2010	Nine months 2011	Nine months 2010
Total revenue	$9.30bn	$8.35bn	$27.78bn	$25.32bn
Net income	$444.8m	$393.2m	$1.22bn	$992.1m
Diluted EPS	$2.67	$2.32	$7.24	$5.84
Benefit ratio	80.7%	81.6%	82.2%	82.4%
Operating cost ratio	14.8%	12.1%	13.9%	12.6%

Nine-month revenue increased 9.7%; premiums rose 7.3% and services revenue rose 162.2%, primarily reflecting Concentra, acquired in December 2010, and growth in primary-care services.
Nine-month net income increased 23.0%. Management attributed improved results principally to Retail and Health and Well-Being Services. The 2010 comparison included a $147.5m deferred-acquisition-cost write-down; 2011 results benefited from favorable prior-period claims reserve development of $151m, versus $194m in 2010.
The nine-month benefit ratio improved 20 basis points, while the operating cost ratio worsened 130 basis points. Higher operating costs reflected Concentra, Retail Medicare sales-season expenses, and the changing business mix; the 2010 write-down also affects comparison.
Operating cash flow was $3.88bn versus $2.29bn. The 2011 figure included an early $1.80bn Medicare premium receipt for October, making the period include ten monthly Medicare payments versus nine in 2010. Cash and equivalents were $4.02bn at September 30.
At September 30, total investment securities were about $9.56bn and long-term debt was $1.66bn. Total assets were $19.90bn and total liabilities $12.04bn. The $1.0bn revolving credit facility was undrawn, with $988.4m of remaining capacity; Humana reported covenant compliance and a 0.6:1 leverage ratio under the agreement.
Operating, investing, and financing cash flows for the nine months were $3.88bn, negative $1.14bn, and negative $386.5m, respectively. Share repurchases totaled $491.5m under board authorizations, and $41.5m in dividends were paid.

Material changes and management commentary

Retail premiums grew 12.1% for the nine-month period, supported by individual Medicare Advantage membership growth. Individual Medicare Advantage membership was 1.61m at September 30, up 10.3% year over year; individual stand-alone prescription drug plan membership was 2.48m, up 46.8%, partly reflecting the Humana Walmart-Preferred Rx Plan.
Employer Group premiums fell 2.4% year to date, with commercial group membership declines partly offset by Medicare Advantage growth. Q3 segment pretax income declined 41.9% to $45.9m, primarily due to a higher benefit ratio; nine-month pretax income rose 12.6% to $293.0m.
Health and Well-Being Services nine-month pretax income increased 53.3% to $267.7m, principally due to pharmacy growth and Concentra. Other Businesses nine-month pretax income declined $26.1m, primarily due to lower income from the CMS LI-NET contract.
CMS announced an average 0.4% sector-wide Medicare Advantage payment-rate increase for 2012. Management said it designed products for this rate environment and expects cost-reduction and care-management initiatives to help, but gave no specific earnings guidance in the provided filing text.
Management expected 2011 capital expenditures, excluding acquisitions, of approximately $305m, versus $222m in 2010, and stated that cash, investments, operating cash flow, and financing availability were adequate for operating and regulatory needs, expansion, capital spending, and debt obligations for at least 12 months.

Outlook, risks, contingencies, and unusual items

Humana had definitive agreements to acquire Arcadian Management Services and MD Care, together serving about 79,000 Medicare Advantage HMO members across 15 states; closings remained subject to regulatory approvals.
The TRICARE South Region contract award to Humana was upheld by the Court of Federal Claims on October 14, 2011. The unsuccessful bidder could appeal by December 13, 2011; final disposition remained uncertain.
Six Humana contracts were selected for CMS Medicare risk-adjustment data validation audits. Humana challenged CMS’s proposed audit and payment-adjustment methodology, warning that implementation without changes could materially affect results, financial position, and cash flows.
Humana disclosed an ongoing internal investigation into aspects of its Florida subsidiary operations, voluntarily reported to CMS, the Department of Justice, and Florida regulators. The matters include employee-provider relationships, Medicaid enrollment support practices, and financial support to physician practices. Potential loss estimates for the described matters were not provided; the filing says penalties or sanctions could be substantial.
Other litigation includes provider disputes involving TRICARE outpatient reimbursements; a related arbitration hearing concluded in October 2011, with a decision pending. Humana said it could not estimate possible loss beyond amounts accrued for the described legal matters.
Government programs accounted for approximately 77% of nine-month premiums and services revenue. Risks include Medicare and Medicaid payment or policy changes, Health Insurance Reform implementation and assessments, potential federal deficit-related spending reductions, and the effect of Star Ratings on Medicare Advantage quality bonuses.
Humana reported $35.8m of gross unrealized investment losses and no material other-than-temporary impairments. It estimated that a 1% increase in interest rates would generally reduce the fair value of its securities by approximately $418m.
Segment reporting and certain revenue and expense classifications changed in 2011; prior periods were recast, and the reclassifications had no impact on net income, cash flows, or equity. A new quarterly dividend policy began in 2011; future dividends remain at the board’s discretion.

Key facts for investors to verify

Whether Medicare Advantage risk-adjustment audit methodology or findings lead to payment adjustments, and the potential financial exposure.
Regulatory approval and integration progress for Arcadian and MD Care, and the final status of the TRICARE contract appeal.
Developments and any remediation, penalties, or financial consequences from the Florida investigation and provider litigation.
Underlying cash generation after removing the timing benefit from the early Medicare premium receipt, and the sustainability of favorable claims-reserve development.
How Medicare payment policy, Health Insurance Reform requirements, Star Ratings, and government spending changes affect enrollment, benefit ratios, and margins.