Business context and reporting period
WellPoint, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2013. The health benefits company reported 35.5 million medical members. Results reflect the December 2012 Amerigroup acquisition; beginning in Q2 2013, WellPoint reported three segments: Commercial and Specialty Business, Government Business, and Other.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Operating revenue | $17,733.0 million | $15,133.7 million | $52,876.5 million | $45,457.2 million |
| Net income | $656.2 million | $691.2 million | $2,341.5 million | $2,191.3 million |
| Diluted EPS | $2.16 | $2.15 | $7.69 | $6.63 |
| Benefit expense ratio | 84.9% | 85.4% | 84.1% | 84.7% |
| SG&A ratio | 14.5% | 13.7% | 14.0% | 13.9% |
- Q3 operating revenue rose 17.2%, while net income fell 5.1%; diluted EPS edged up 0.5%, aided by fewer shares outstanding. Nine-month operating revenue increased 16.3%, net income 6.9%, and diluted EPS 16.0%.
- Q3 net margin was 3.7% versus 4.5% a year earlier; the nine-month net margin was 4.4% versus 4.7%. Q3 segment operating gain was $688.2 million for Commercial and Specialty (down 19.3%) and $326.5 million for Government (up 93.2%).
- Nine-month operating cash flow was $2,779.5 million, up from $1,984.8 million. Investing used $2,086.8 million and financing used $992.0 million; cash and cash equivalents ended at $2,185.7 million.
- Cash, cash equivalents, and investments totaled $23,208.5 million at September 30, 2013. Long-term debt was $14,514.1 million; the company reported a 37.5% debt-to-capital ratio, above its 25%–35% target range. It had $794.9 million outstanding under its commercial paper program and no borrowings under its $2.0 billion revolving facility.
Material changes and management commentary
- Government Business revenue grew 47.6% in Q3, primarily from Amerigroup, while Commercial and Specialty revenue was nearly flat. Medical membership increased 6.0% year over year, principally due to Amerigroup Medicaid members; Commercial and Specialty membership declined 1.3%.
- Management cited health care reform implementation project costs and higher incentive compensation as contributors to increased SG&A. It estimated 2013 cost-of-care trend for its Local Group fully insured business at approximately 6.0%, plus or minus 50 basis points.
- Management described liquidity as strong and said operating cash flow, cash and investments, and available financing were expected to support operations and commitments. It expected over time to return debt-to-capital to its target range, without providing a timetable or formal full-year earnings guidance in the provided filing text.
Risks, contingencies, and unusual items
- Debt transactions generated a $145.3 million loss on extinguishment in Q3: WellPoint repurchased $700 million principal of notes for $837.7 million and redeemed $400 million principal for $411.0 million. It also issued $1.25 billion of notes, at 2.300% due 2018 and 5.100% due 2044.
- Other-than-temporary investment impairment losses recognized in income were $73.1 million for the nine months, versus $20.6 million in 2012. Management warned further material impairment losses could occur; investment market-value changes also drove a $303.9 million nine-month other comprehensive loss.
- For specified legal proceedings where loss was probable or reasonably possible and estimable, the company estimated aggregate possible losses above established reserves at $0–$350 million. It could not estimate potential exposure from the Penn Treaty rehabilitation/insolvency proceedings, which could result in future guaranty-fund assessments.
- Key risks include health care reform and regulation, medical cost trends and premium-rate approvals, Medicare and Medicaid requirements and funding, Amerigroup integration, competition and membership/product mix, litigation and investigations, investment-market volatility, regulatory limits on subsidiary distributions, and substantial indebtedness. Management noted no material changes to the risk factors in its 2012 Form 10-K.
Important facts for investors to verify
- How much of revenue and membership growth is attributable to Amerigroup, and whether that growth translates into sustained segment profitability.
- Whether Commercial and Specialty margins recover as health care reform implementation costs and other elevated SG&A costs change.
- Medical claims reserve development: nine-month favorable prior-year development was $560.1 million; review assumptions and subsequent claims experience.
- Debt reduction plans, the timing of a return to the stated leverage target, and the impact of debt refinancing and repurchases on interest expense and liquidity.
- Potential investment impairment exposure, litigation outcomes and reserves, and any Penn Treaty assessments.
- Any subsequent outlook or guidance: this filing provides a cost-trend estimate for a specified business line, but no clear full-year earnings guidance.