Humana Inc. Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. Unaudited results. Humana operates Retail, Group and Healthcare Services businesses, with substantial exposure to Medicare products.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $13.694 billion | $13.363 billion | $41.501 billion | $40.928 billion |
| Operating income | $949 million | $695 million | $2.179 billion | $2.058 billion |
| Net income | $450 million | $314 million | $1.015 billion | $1.175 billion |
| Diluted EPS | $2.98 | $2.09 | $6.73 | $7.77 |
| Benefit ratio | 81.5% | 83.9% | 83.6% | 84.0% |
| Operating cost ratio | 12.9% | 12.8% | 12.7% | 13.4% |
Q3 revenue grew 2.5% and net income rose 43.3% year over year. Nine-month revenue grew 1.4%, while net income declined 13.6%. Nine-month 2015 included a $267 million pretax gain from the Concentra sale; 2016 included a $208 million increase in the individual commercial medical premium deficiency reserve (PDR). The PDR increase represented $0.86 per diluted share. Nine-month results also included $81 million of Aetna merger transaction and integration costs and a $20 million share-based-payment tax benefit.
Benefits expense was $10.9 billion in Q3 and $33.8 billion year to date. Favorable prior-period claims reserve development was $90 million in Q3 2016 versus $67 million in Q3 2015, and $525 million year to date versus $245 million. Management attributed improved Retail results in part to lower Medicare Advantage utilization and favorable reserve-development comparisons.
For the nine months, Retail pretax income was $1.118 billion, up 16.5%; Group was $271 million, up 14.8%; and Healthcare Services was $800 million, up 8.5%. Group Q3 pretax income fell to $12 million from $39 million. Healthcare Services growth reflected pharmacy and home-based services, partly offset by lower Medicare rates affecting provider services.
Cash flow, balance sheet and liquidity
- Operating cash flow was $4.709 billion for the first nine months, compared with $531 million in 2015. The 2016 figure included a $3.0 billion Medicare premium remittance received early in September for October coverage because October 1 fell on a weekend; the period therefore included ten monthly Medicare payments versus nine in 2015. Management also cited favorable working-capital timing and higher earnings excluding the Concentra gain and PDR increase.
- Investing cash flow was an outflow of $534 million; financing cash flow was an inflow of $23 million. Capital expenditures were $395 million.
- At September 30, cash and cash equivalents were $6.769 billion, versus $2.571 billion at year-end 2015. Current and long-term investment securities totaled $9.602 billion. Total assets were $29.466 billion and stockholders’ equity was $11.285 billion.
- Debt comprised $3.792 billion of long-term debt and $300 million of commercial paper. Humana had $1.0 billion available under its revolving credit facility, no facility borrowings, and reported covenant leverage of 1.4:1 against a 3.0:1 maximum.
- Unearned revenues increased to $3.351 billion from $364 million at year-end, primarily reflecting the early Medicare premium remittance. The company separately reported collection of approximately $2.0 billion from CMS on November 1, 2016, primarily for 2015 Part D subsidies.
Outlook, material developments and risks
- Aetna merger: The proposed transaction provides $125 cash and 0.8375 Aetna shares per Humana share. The DOJ and several state jurisdictions sued to block it; trial was scheduled to begin December 5, 2016. The parties extended the merger agreement end date to December 31, 2016. Humana and Aetna agreed to sell certain Medicare Advantage assets to Molina for approximately $117 million in aggregate, subject to merger completion, litigation resolution and regulatory approvals. Humana said the closing timing and outcome could not be predicted.
- Medicare outlook: Humana estimated average 2017 Medicare Advantage funding decreases of approximately 1.3%, with geographic results varying. CMS’s 2018 bonus-year ratings showed about 37% of July 2016 MA membership in plans rated four stars or higher, down from about 78% a year earlier. Humana planned operational actions and to seek reconsideration of certain ratings; it said the ratings were not expected to materially affect 2017 Medicare revenue or membership growth.
- Individual commercial plans: Humana planned to offer on-exchange plans in 11 states in 2017, compared with 15 in 2016, and discontinue substantially all compliant off-exchange plans. It expected 2017 premiums of $1 billion to $1.25 billion, versus projected 2016 premiums of approximately $3.4 billion. The 2016 PDR increase reflected unfavorable current and projected claims experience.
- Health insurer fee and taxes: The 2016 fee payment was $916 million and is nondeductible. A one-year 2017 suspension was expected to significantly reduce operating costs and the effective tax rate. Humana estimated a 2016 effective tax rate of 49%–51%, excluding specified merger costs incurred after September 30.
- Contingencies and policy risk: The company reported Medicare risk-adjustment audits and related investigations, other lawsuits and regulatory reviews, and uncertainty over collection of Affordable Care Act risk-corridor and other program receivables. It stated that potential losses beyond accrued amounts could not be estimated for the described legal matters and that outcomes could be material. Risk-corridor receivables are subject to funding and collection uncertainty.
- Investment risk: Approximately 98% of debt securities were investment grade. Management reported $25 million of gross unrealized losses and no material other-than-temporary impairments. A 1 percentage-point increase in interest rates was estimated to reduce securities’ fair value by approximately $500 million.
Key facts for investors to verify
- Whether the merger, DOJ litigation and proposed Molina divestitures receive the required court and regulatory approvals, and the resulting transaction timeline.
- How much of the reported operating cash flow reflects recurring operations versus the early $3.0 billion Medicare remittance and other working-capital timing.
- Whether the $206 million remaining PDR and reduced 2017 individual-market footprint adequately reflect claims experience, enrollment and market conditions.
- The financial and membership effects of 2017 MA funding changes and the reduced proportion of members in four-star-or-higher plans for the 2018 bonus year.
- Collection timing and recoverability of risk-corridor and other health reform receivables, and developments in Medicare risk-adjustment audits and legal proceedings.