Humana Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Financial statements are unaudited. Humana is a health insurer and health-services company; Medicare Advantage and Part D are central to its business.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $14.206B | $13.282B | $42.744B | $40.578B |
| Operating income | $961M | $858M | $2.583B | $3.696B |
| Net income | $644M | $499M | $1.328B | $2.264B |
| Diluted EPS | $4.65 | $3.44 | $9.58 | $15.44 |
| Benefit ratio | 82.0% | 82.1% | 83.5% | 83.1% |
| Operating cost ratio | 13.5% | 12.8% | 12.8% | 11.7% |
| Effective tax rate | 29.1% | 37.5% | 18.8% | 35.9% |
Q3 revenue rose 7.0%, net income 29.1%, and diluted EPS 35.2% year over year. For the nine-month period, revenue increased 5.3%, while net income declined 41.3% and diluted EPS declined 38.0%. The filing attributes the divergent earnings comparisons substantially to the 2018 KMG sale loss and the 2017 Aetna merger termination gain, alongside business and tax changes.
- Revenue drivers: Nine-month premiums increased 4.2% to $41.236B, mainly from Retail Medicare Advantage growth. Services revenue increased 54.4% to $1.090B, with growth in Healthcare Services and Group and Specialty. Individual Commercial premiums fell sharply following Humana’s exit from that business effective January 1, 2018.
- Claims and expenses: Nine-month benefits expense rose 4.8% to $34.449B. Favorable prior-year medical claims reserve development was $467M, versus $430M a year earlier. Management cited a more severe flu season and enhanced Medicare Advantage benefits as pressures on the year-to-date benefit ratio. Operating costs increased 15.3%; the operating cost ratio rose partly because the health-insurance industry fee returned in 2018 and Humana made strategic investments.
- Cash flow: Operating cash flow was $2.506B for nine months, versus $6.962B in 2017. The comparison reflects, among other factors, a $3.1B early Medicare premium remittance and the $1B Aetna termination payment in 2017; 2018 cash flow also included about $245M related to KMG reinsurance. Investing cash use was $2.640B, including the Kindred at Home/Curo investment and acquisitions. Cash and cash equivalents were $4.142B at September 30, versus $4.042B at year-end 2017.
- Balance sheet and liquidity: Total assets were $27.490B and stockholders’ equity $10.593B. Debt comprised $4.774B of long-term debt and $398M of commercial paper. Humana reported $2.0B of unused capacity under its revolving credit agreement, compliance with its 50% maximum debt-to-capitalization covenant (actual 32.8%), and stated that available resources were adequate for at least the next 12 months.
Material changes and unusual items
- Humana sold its closed-block commercial long-term-care subsidiary KMG on August 9, recognizing a $786M pretax loss and a $430M related tax benefit. The sale included $805M of cash and cash equivalents among the disposed assets. The sale and associated tax benefit materially affected year-to-date results.
- In 2017, Humana recorded a net $947M benefit related mainly to the Aetna merger breakup fee. The 2017 comparison also benefited from the suspension of the health-insurance industry fee; that fee resumed in 2018. Humana paid approximately $1.04B for the 2018 fee in October, and it is currently suspended for 2019 under law.
- Humana acquired a 40% interest in Kindred at Home and Curo for approximately $1.1B in cash; it accounts for the investment under the equity method. The related sponsor put and Humana call options had reported fair values of $221M and $265M, respectively, at quarter-end.
- Other acquisitions included MCCI and Family Physicians Group. Humana also continued share repurchases and declared a $0.50-per-share dividend in November 2018, payable in January 2019.
Outlook, management commentary and risks
- No consolidated earnings or revenue guidance is stated in the provided filing text. Management said liquidity resources should cover operating and regulatory needs, acquisitions, capital spending, debt service and repurchases for at least 12 months.
- Humana said its 2019 Medicare Advantage rate increase was expected to be slightly below CMS’s sector estimate on a comparable basis, citing the geographic mix of its members. CMS approved Humana’s 2019 product offerings. Updated Star ratings placed 84% of its Medicare Advantage membership in contracts rated four stars or higher for 2019. Humana also reported a notice of intent for a comprehensive Florida Medicaid contract and notice that the TRICARE East contract option would be exercised for 2019.
- Key regulatory exposure includes CMS Medicare Advantage risk-adjustment data validation (RADV) audits and a proposed methodology that could apply extrapolation without a fee-for-service adjustment. Humana warned that adoption as proposed could materially adversely affect results, financial position or cash flows. CMS appealed a court decision vacating its Overpayment Rule.
- Humana is cooperating with a Department of Justice information request concerning Medicare risk-adjustment practices and is defending a False Claims Act qui tam case. Its approximately $611M lawsuit seeking unpaid federal risk-corridor payments remains stayed; Humana has recorded no receivable or revenue for the claim. The filing says potential outcomes of legal and regulatory matters cannot be reliably estimated and could be material.
- Interest-rate risk remains relevant: the investment portfolio had $273M of gross unrealized losses, which Humana attributed primarily to rising rates, and estimated that a 1-percentage-point rate increase would reduce securities’ fair value by approximately $356M. No material other-than-temporary impairments were recorded in the nine-month period.
Important facts for investors to verify
- How much of earnings reflects recurring operating performance versus the KMG loss, the prior-year merger fee, tax effects, and favorable claims reserve development?
- Whether CMS’s final RADV methodology, audits, or risk-adjustment data requirements create material payment or repayment exposure.
- Whether the higher operating cost ratio and Medicare Advantage benefit costs persist, and how the 2019 industry-fee suspension affects comparisons.
- Cash-flow trends after separating Medicare payment timing, KMG-related cash movements, acquisitions, and other working-capital changes.
- Performance and valuation of the Kindred at Home/Curo investment, including the future sponsor put and call options.