UNITEDHEALTH GROUP INC quarterly report, Q2 FY2013

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UnitedHealth Group Inc. — Q2 2013 Form 10-Q

Business context and period. Diversified health and well-being company operating through UnitedHealthcare (coverage and benefits) and Optum (health services). This unaudited filing covers the quarter and six months ended June 30, 2013; comparisons are with the same 2012 periods. Financial amounts below are in U.S. dollars.

Key financial metrics

  • Revenue: Q2 revenue was $30.4 billion, up 12%; six-month revenue was $60.7 billion, up 11%. Growth reflected acquisitions, membership expansion and Optum growth, partly offset by a large customer’s shift from risk-based to fee-based coverage.
  • Profit and EPS: Q2 net earnings attributable to common shareholders were $1.44 billion, up 7%, and diluted EPS was $1.40, up 10%. For the first half, attributable earnings were $2.63 billion, down 4%, and diluted EPS was $2.56, down 1%.
  • Operating results and margins: Q2 operating earnings rose 8% to $2.40 billion; operating margin was 7.9% versus 8.2%. Six-month operating earnings were essentially flat at $4.54 billion, with margin of 7.5% versus 8.3%. Medical care ratio was 81.5% in Q2 (81.3% a year earlier) and 82.1% for six months (81.1%).
  • Segment trends: Q2 UnitedHealthcare revenue rose 11% to $28.3 billion, but operating earnings fell 2% to $1.87 billion and margin declined to 6.6% from 7.5%. Optum revenue increased 21% to $8.84 billion and operating earnings increased 68% to $536 million.
  • Cash flow: First-half operating cash flow was $2.53 billion, down from $5.77 billion; the filing attributes much of the comparison to an early CMS payment received in 2012. Investing activities used $1.02 billion and financing activities used $2.17 billion. Cash and cash equivalents decreased $752 million to $7.65 billion.
  • Liquidity and debt: Cash, cash equivalents and available-for-sale investments totaled $27.3 billion, including $1.2 billion available for general corporate use. Commercial paper and long-term debt carrying value totaled $16.6 billion; commercial paper outstanding was $901 million at a 0.3% weighted-average rate. Revolving facilities of $4.0 billion were undrawn. Debt-to-debt-plus-equity was 34.6%; the company reported compliance with its 50% covenant limit.
  • Capital returns: The company repurchased 23 million shares for $1.3 billion in the first half. The annual dividend rate was raised to $1.12 per share in June.

Material changes versus the prior comparable period

  • Q2 earnings improved, while first-half attributable earnings and EPS declined modestly; first-half operating earnings were nearly unchanged despite revenue growth.
  • Membership increased 25% to 45.0 million medical members, including 4.7 million international members and 2.9 million TRICARE beneficiaries. The 1.1 million-member customer conversion reduced reported revenue but management said earnings and cash-flow effects were negligible.
  • UnitedHealthcare’s margin was pressured by Medicare and Medicaid funding reductions and TRICARE implementation costs. Optum’s earnings and margins improved across its businesses.
  • Amil’s remaining public shares were acquired for $1.5 billion, bringing UnitedHealth Group’s ownership to 90%.
  • Other comprehensive loss was $973 million for the first half, primarily reflecting foreign currency translation losses and unrealized investment losses; shareholders’ equity was $31.4 billion at June 30.

Outlook, risks and unusual items

  • Management expected 2013 commercial medical cost trend of 5.5%, plus or minus 0.5 percentage points, and pharmacy trend flat to slightly lower than 2012. It expected ongoing pressure on commercial risk-based membership and on Medicare and Medicaid margins.
  • Management estimated sequestration would reduce 2013 consolidated pretax earnings by $250–$300 million. It cited 2014 Medicare Advantage payment reductions and the new 85% minimum medical loss ratio as risks to plan benefits, participation, membership and earnings; the company expected to exit markets serving about 150,000 Medicare Advantage beneficiaries in 2014.
  • The Affordable Care Act insurance industry tax begins in 2014; management expected a significant increase in the effective tax rate that year. The company expected to participate selectively in about 12 individual and small-group exchanges in 2014.
  • Favorable medical cost development was $120 million in Q2 2013, including $190 million related to the current year; first-half prior-year development was $400 million, versus $620 million a year earlier. Management attributed favorable development primarily to lower-than-expected utilization.
  • Contingencies include a California regulatory matter in which the regulator seeks approximately $325 million; the company said it could not reasonably estimate potential loss. A Nevada jury awarded $24 million in compensatory and $500 million in punitive damages in an endoscopy-center case; the company is appealing and could not estimate loss across related suits.
  • Key exposures include regulatory changes and audits (including Medicare risk-adjustment validation), litigation, medical-cost estimates, interest and currency movements, and execution of the Amil and pharmacy-benefit transitions. Management said disclosure controls were effective and there were no material changes to internal control over financial reporting.

Most important facts for investors to verify

  1. How the Medicare and Medicaid funding changes, 2014 insurance tax and 85% Medicare Advantage medical loss ratio affect pricing, membership and margins.
  2. Whether medical-cost development and utilization trends remain favorable, and how medical care ratio develops as business mix changes.
  3. Whether Optum’s growth and margin improvement can continue, and whether UnitedHealthcare can stabilize operating margins.
  4. The timing and cash-flow effects of CMS payments, the Amil acquisition, and the OptumRx transition of pharmacy members.
  5. Developments in the California regulatory matter, Nevada litigation and Medicare risk-adjustment audits, including any resulting liability or payment adjustments.
  6. Liquidity available for corporate use, debt and credit ratings, and the effect of foreign-exchange and investment-market changes.