Humana Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2017. Financial statements are unaudited. Humana is a health insurer and healthcare services company, with major exposure to Medicare Advantage and Part D.
Financial results and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $13.534 billion | $14.007 billion | $27.296 billion | $27.807 billion |
| Operating income | $1.100 billion | $683 million | $2.838 billion | $1.230 billion |
| Net income | $650 million | $311 million | $1.765 billion | $565 million |
| Diluted EPS | $4.46 | $2.06 | $11.98 | $3.75 |
| Benefit ratio | 82.5% | 84.3% | 83.5% | 84.6% |
| Operating cost ratio | 10.8% | 12.2% | 11.1% | 12.4% |
| Effective tax rate | 37.6% | 51.1% | 35.4% | 50.3% |
Cash flow: Six-month operating cash flow was $4.099 billion, versus $206 million in 2016; investing cash use was $1.078 billion and financing cash provided was $1.241 billion. Cash and cash equivalents ended the period at $8.139 billion, compared with $3.877 billion at year-end 2016. The operating cash flow comparison is substantially affected by timing and one-time receipts, described below.
Balance sheet and debt: Total assets were $32.253 billion and total liabilities $21.300 billion at June 30. Total debt was $4.980 billion, including $701 million short-term and $4.279 billion long-term; commercial paper outstanding was $200 million. Humana had no borrowings under its $2.0 billion revolving credit facility and reported $2.0 billion of available capacity. The company reported covenant compliance, with a 1.1:1 leverage ratio against a 3.0:1 maximum.
Changes versus prior comparable periods
- Q2 revenue declined 3.4%, while net income rose 109.0%. For the first half, revenue declined 1.8%, while net income rose 212.4% and diluted EPS rose 219.5%.
- First-half earnings include a $947 million net gain, mainly the $1 billion Aetna merger termination fee, or $4.31 per diluted share. The 2016 comparison included a $208 million increase to the Individual Commercial premium deficiency reserve in Q2. These items materially affect year-over-year earnings comparisons.
- Premiums fell as Individual Commercial business contracted, partly offset by Medicare growth. Q2 premiums decreased 3.3%; Retail premiums grew 3.1%, while Individual Commercial premiums fell 75.9%.
- Lower operating costs and tax rates benefited 2017 results. The 2017 suspension of the non-deductible health insurance industry fee reduced costs and taxes; the fee is scheduled to resume in 2018. Share repurchases also reduced weighted-average shares.
- Retail pretax income increased to $607 million in Q2 and $977 million for the first half. Group and Specialty pretax income declined 18.5% in Q2 and 8.1% for the first half; Healthcare Services pretax income declined 3.2% in both comparisons.
Outlook, management commentary, and material risks
- Individual Commercial exit: Humana plans to exit its Individual Commercial medical business beginning January 1, 2018, citing signs of an unbalanced exchange risk pool. The company had reduced its 2017 on-exchange presence to 11 states and discontinued substantially all compliant off-exchange plans.
- Medicare outlook: Humana estimated the 2018 Medicare Advantage rate notice would produce a 0.45% rate increase, compared with CMS’s 0.85% sector estimate on a comparable basis, excluding several specified factors. It expected 74% of June 2017 Medicare Advantage membership to be in plans rated 4 stars or higher for 2018 bonus purposes.
- Other operations: The start of the new TRICARE East Region contract was moved from October 1, 2017 to January 1, 2018. Management described its integrated-care and value-based provider strategy; 64.8% of individual Medicare Advantage members were in value-based relationships at June 30.
- Cash flow qualification: Operating cash flow included an early $3.1 billion Medicare premium remittance for July, received in June because July 1 fell on a weekend, and the merger termination fee. Management said working-capital timing otherwise weighed on cash flow, partly offset by higher earnings.
- Regulatory and collection exposure: Humana had written off $583 million of risk-corridor receivables in 2016 and reported an estimated $611 million entitlement for 2014–2016 program years at June 30, 2017. Recovery remains uncertain. Separately, the net receivable under the commercial risk-adjustment, reinsurance, and risk-corridor programs was about $411 million, excluding risk-corridor receivables; $409 million related to prior coverage years was expected to be collected in Q3 2017.
- Government-program risks: CMS risk-adjustment data validation audits, the transition from RAPS to encounter data, and potential changes to Medicare, Medicaid, or health reform programs could affect payments and results. CMS audits covered multiple Humana contracts; management said estimated settlements based on internal audits were not material but could not determine whether the audits would ultimately have a material adverse effect.
- Legal and unusual items: A Florida qui tam case was scheduled for trial in November 2017, and the company was responding to government inquiries concerning Medicare risk-adjustment practices. Losses, if any, could not be reasonably estimated beyond accrued amounts. A $54 million estimate for state guaranty assessments following Penn Treaty’s liquidation was recorded in Q1.
- Capital and market risks: Humana issued $1 billion of senior notes in March and repurchased shares under a $1.5 billion accelerated repurchase agreement. Parent-company liquidity also funded a $535 million contribution to its long-term-care subsidiary. Management stated available liquidity was adequate for at least the next 12 months. A 1% increase in interest rates was estimated to reduce investment fair value by approximately $678 million.
The filing does not provide a clear quantified full-year earnings guidance figure.
Important facts for investors to verify
- How much of the 2017 earnings improvement is attributable to the Aetna termination gain, the prior-year reserve charge, fee suspension, and lower taxes rather than recurring operations.
- Whether the $611 million risk-corridor entitlement and other 3R receivables are collectible, and whether CMS settlements or audit findings change estimates.
- Progress and financial effects of the planned Individual Commercial exit, including run-off claims, remaining obligations, and 2018 earnings impact.
- Medicare Advantage rate and Star-rating outcomes, risk-adjustment data transition effects, and the timing and economics of the TRICARE East launch.
- Cash flow after the unusually timed Medicare remittance and merger receipt, and the effects of debt issuance, share repurchases, dividends, and long-term-care capital support on liquidity.