Humana Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. Comparisons are with Q1 2016 unless otherwise noted. Amounts are in U.S. dollars.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $13.762 billion | $13.800 billion | Down 0.3% |
| Operating income | $1.738 billion | $547 million | Up $1.191 billion |
| Net income | $1.115 billion | $254 million | Up $861 million |
| Diluted EPS | $7.49 | $1.68 | Up $5.81 |
| Benefits expense / benefit ratio | $11.326 billion / 84.5% | $11.397 billion / 84.8% | Ratio improved 0.3 percentage points |
| Operating cost ratio | 11.4% | 12.7% | Improved 1.3 percentage points |
| Operating cash flow | $4.205 billion | $502 million | Up $3.703 billion |
Results were dominated by the terminated Aetna merger: Humana recorded a net gain of $947 million, primarily the $1 billion breakup fee, compared with $34 million of merger-related costs in Q1 2016. The filing reports no separate adjusted or merger-excluded earnings measure. Other items affecting comparison include the 2017 suspension of the health insurance industry fee, which reduced costs and the tax rate, and a $54 million assessment related to Penn Treaty. The effective tax rate was 34.0%, versus 49.2%.
Cash, debt and liquidity
- Cash and cash equivalents were $8.425 billion at March 31, 2017, versus $3.877 billion at year-end 2016. Current and long-term investment securities totaled $10.629 billion.
- Operating cash flow included the early receipt of approximately $3.1 billion in April Medicare premiums and the $1 billion merger termination fee. Management said working-capital timing otherwise weighed on cash flow, partly offset by higher earnings.
- Investing activities used $926 million; financing activities provided $1.269 billion. The company repurchased $1.574 billion of stock and paid $47 million in dividends. It issued $1 billion of senior notes, receiving net proceeds of $991 million.
- Long-term debt was $4.780 billion and commercial paper borrowings were $470 million. The $1 billion revolving credit facility was undrawn, leaving $1 billion available. The company reported compliance with credit covenants, including a 1.3:1 leverage ratio against a 3.0:1 maximum.
- Management said available cash, investments, operating cash flows and financing capacity should fund operating and regulatory needs for at least the next 12 months. State-regulated subsidiaries had $7.7 billion of statutory capital and surplus against $4.8 billion of minimum requirements; estimated 2017 ordinary dividends available to the parent were approximately $850 million, subject to regulatory limits.
Material changes and segment trends
- Retail: Revenue rose 4.9% to $11.408 billion and pretax income rose to $370 million from $141 million. Medicare membership growth and lower benefit and operating cost ratios contributed. Retail medical membership increased 5.7% to 9.082 million.
- Group and Specialty: Revenue increased 1.3% to $1.861 billion; pretax income was nearly flat at $171 million. The benefit ratio worsened to 75.6% from 73.6%, partly offset by lower operating costs. Group ASO membership fell 22.9%.
- Healthcare Services: Pretax income declined 3.2% to $244 million. Management cited optimization of chronic-condition programs; pharmacy script volume increased 2.9%.
- Individual Commercial: Pretax income was $63 million versus a $12 million loss, while membership fell 77.0%. Results reflected market exits, premium increases and prior-year reserve effects. Segment reporting was realigned in 2017, with prior-period data recast.
- Prior-period claims reserve development was favorable by $231 million, compared with $340 million in Q1 2016; it reduced the consolidated benefit ratio by approximately 170 basis points versus 250 basis points in the prior-year quarter.
Outlook, risks and unusual items
- Humana and Aetna mutually terminated their merger agreement in February after a federal court permanently enjoined the transaction. Humana received the contractual $1 billion breakup fee. The merger termination gain materially inflates reported Q1 earnings.
- Humana announced it will exit individual commercial medical coverage beginning January 1, 2018, citing continued signs of an unbalanced exchange risk pool.
- For 2018, management estimated the CMS Medicare Advantage rate notice would produce a 0.45% rate increase for Humana, compared with CMS’s sector estimate of 0.85%, before specified adjustments. The share of Humana Medicare Advantage members in plans rated four stars or higher fell to approximately 37% from 78%; management said this could materially affect 2018 revenue, pretax results and cash flow, while noting mitigation efforts.
- The annual health insurance industry fee was suspended for 2017 but scheduled to resume in 2018. Humana paid $916 million for its 2016 fee.
- Humana estimated it was entitled to $613 million of commercial risk corridor payments for 2014–2016, but noted litigation outcomes and program funding uncertainty. It had previously written off $583 million of risk corridor receivables in Q4 2016. Net receivables under the commercial risk-adjustment, reinsurance and risk-corridor programs were approximately $394 million at quarter-end, excluding risk corridor receivables.
- Other material uncertainties include CMS Medicare risk-adjustment audits and encounter-data changes, government contract protests and renewals, healthcare reform changes, and legal and regulatory matters. A Florida qui tam matter was scheduled for trial in November 2017; Humana said possible losses beyond accrued amounts could not be estimated. The company recorded a $54 million estimate for state guaranty assessments following Penn Treaty’s liquidation.
- Interest-rate sensitivity: management estimated that a 1 percentage-point increase in rates would reduce the fair value of securities by approximately $640 million. It reported $165 million of gross unrealized investment losses, primarily attributed to higher market rates, and no material other-than-temporary impairments in the quarter.
Important facts for investors to verify
- How much of reported earnings and cash generation is attributable to the merger fee and timing of Medicare premium receipts, rather than recurring operations?
- What financial effects will follow the planned 2018 individual commercial exit and the decline in Medicare Advantage star ratings?
- What is the collectability and timing of risk-program receivables, and what exposure could result from CMS audits or legal proceedings?
- How will the 2018 resumption of the health insurance industry fee, share repurchases and increased debt affect cash, earnings and regulatory capital?