Humana Inc. — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; balance-sheet comparisons are with December 31, 2009. Interim financial statements are unaudited. Humana operates Government and Commercial segments and reported approximately 10.4 million medical members and 7.2 million specialty members.
Key financial metrics
| Metric | Q1 2010 | Q1 2009 / comparison |
|---|---|---|
| Total revenue | $8.441 billion | $7.712 billion; up 9.5% |
| Premium revenue | $8.162 billion | $7.471 billion; up 9.2% |
| Operating income | $443.2 million | $320.5 million |
| Net income | $258.8 million | $205.7 million |
| Diluted EPS | $1.52 | $1.22 |
| Benefits / benefit ratio | $6.808 billion / 83.4% | $6.269 billion / 83.9% |
| SG&A expense / ratio | $1.127 billion / 13.5% | $1.064 billion / 13.9% |
| Operating cash flow | $754.7 million | $45.5 million |
| Cash and cash equivalents | $1.814 billion | $1.614 billion at Dec. 31, 2009 |
| Investment securities | $8.099 billion fair value | $7.497 billion at Dec. 31, 2009 |
| Long-term debt | $1.676 billion | $1.678 billion at Dec. 31, 2009 |
Cash, cash equivalents, and investment securities totaled approximately $9.9 billion at quarter-end. Humana had no borrowings under its $1.0 billion revolving credit facility, with $996 million of remaining capacity. Management reported compliance with credit covenants and approximately $3.7 billion of statutory capital and surplus at regulated subsidiaries, $1.3 billion above applicable requirements. The company said available liquidity was adequate for foreseeable operating needs, investment, and debt repayment.
Material changes and business performance
- Government segment pretax income rose 68.1% to $279.2 million; Commercial segment pretax income rose 7.9% to $137.8 million.
- Government premium revenue increased 12.7%, led by Medicare Advantage. Medicare Advantage premium revenue rose 18.6%; fully insured Medicare Advantage membership increased 16.6% year over year to 1.713 million. Stand-alone PDP membership declined 7.8% to 1.917 million.
- Commercial premium revenue declined 1.7%. Commercial medical membership fell 4.0% to 3.332 million, primarily amid competition, unemployment, and employer workforce reductions. Specialty membership grew 10.8% to 7.238 million.
- The consolidated benefit ratio improved 0.5 percentage points. The company attributed much of the period’s earnings improvement to approximately $100 million of prior-year favorable reserve releases not considered ordinary-course development, equivalent to about $0.37 per diluted share. These releases included approximately $86 million in Government and $14 million in Commercial.
- Operating cash flow increased substantially year over year, reflecting Medicare Advantage enrollment growth and the prior-year timing of run-off PDP claims. Q1 2010 operating cash flow also included significant working-capital movements, including a $484.5 million increase in benefits payable and a $281.0 million increase in net receivables.
- The effective tax rate was 37.9%, versus 30.0% in Q1 2009. The prior-year rate benefited from a $16.8 million tax liability reduction; the 2010 rate reflects health-reform limits on deductibility of certain compensation.
Outlook, risks, contingencies, and unusual items
- Health reform: Laws enacted in March 2010 include insurer assessments and premium taxes, Medicare Advantage payment changes, minimum medical-spending requirements, and commercial-market reforms. Humana said implementation and financial effects were uncertain and could materially affect earnings, financial position, and cash flow.
- Medicare Advantage: CMS announced on April 5 that 2011 payment rates would remain flat. Humana said it expected to design competitive products and pursue cost and care-management initiatives, but cautioned execution was not assured. Network requirements are also prompting changes to PFFS products; Humana expected more than 95% of its PFFS members to have the choice of remaining in a Humana plan in 2011.
- CMS risk-adjustment audits: Several Medicare Advantage contracts are under audit. The company could not estimate potential adjustments. It warned that certain retroactive audit methods and extrapolations, if implemented without relief, could materially adversely affect results, financial position, and cash flows.
- TRICARE: The South Region contract was extended through March 31, 2011, but Humana had not secured the follow-on contract. The company said a goodwill impairment could occur in the second half of 2010 if it neither retains the contract nor wins the replacement award. Military services represented approximately 11% of Q1 premiums and ASO fees.
- Other contracts: Puerto Rico Medicaid extensions ran through June 30, 2010, with a new procurement expected. Humana also expected to lose a large ASO group account, reducing membership by approximately 114,000 on July 1, 2010. A CIGNA Group Medicare Advantage alliance was announced, with products expected from July 1 subject to regulatory approval.
- Investment and market risks: The portfolio had $52.3 million of gross unrealized losses, which Humana attributed primarily to interest rates and market liquidity; it reported no material other-than-temporary impairments and did not expect to have to sell loss-position securities before recovery. A 1% rise in interest rates was estimated to reduce securities fair value by approximately $356 million.
- Contingencies: Disclosed matters include Medicare Part D and provider-related litigation, regulatory reviews, and an HHS OIG subpoena concerning Medicare Part D and Humana’s mail-order pharmacy. Humana said outcomes cannot be predicted and could materially affect results, financial position, or cash flows.
- Capital spending and staffing: The company expected approximately $200 million of 2010 capital expenditures, excluding acquisitions, and continued workforce attrition during 2010. Its $250 million share-repurchase authorization remained unused at quarter-end.
Important facts for investors to verify
- How much Q1 earnings growth is repeatable after excluding the approximately $100 million of unusual favorable reserve releases and the prior-year tax benefit.
- CMS audit methodology, timing, and potential financial exposure for Medicare Advantage risk-adjustment reviews.
- Final health-reform rules and their effects on insurer taxes, Medicare Advantage rates, and required medical-spending ratios.
- TRICARE South follow-on contract outcome and any resulting goodwill impairment or exit costs.
- Underlying claims trends and reserve adequacy, given the material working-capital movements and the company’s reliance on estimates for benefits payable.
- Commercial membership and margin trends, the expected ASO account loss, and execution of the announced CIGNA alliance.