Humana Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing was signed February 17, 2017 and includes material events reported after year-end.
Business context
Humana is a health and well-being company operating Retail, Group and Healthcare Services segments. At year-end it served approximately 14.2 million medical members and 7.0 million specialty members. Medicare products generated about 74% of premiums and services revenue; federal government contracts overall accounted for approximately 75%. Individual Medicare Advantage contracts in Florida alone represented 14% of consolidated premiums and services revenue.
Financial performance and position
| Metric | 2016 | 2015 | Change or context |
|---|---|---|---|
| Total revenue | $54.379 billion | $54.289 billion | Up 0.2% |
| Premiums | $53.021 billion | $52.409 billion | Up 1.2% |
| Operating income | $1.741 billion | $2.347 billion | Down 25.8% |
| Income before taxes | $1.552 billion | $2.431 billion | Down 36.2% |
| Net income | $614 million | $1.276 billion | Down 51.9% |
| Diluted EPS | $4.07 | $8.44 | Down 51.8% |
| Benefits expense | $45.007 billion | $44.269 billion | Benefit ratio 84.9%, versus 84.5% |
| Operating costs | $7.277 billion | $7.318 billion | Operating cost ratio 13.5%, versus 13.6% |
| Operating cash flow | $1.936 billion | $868 million | Higher, substantially reflecting favorable working capital |
Reported earnings included a $583 million pretax write-off of commercial risk-corridor receivables, a $505 million pretax strengthening of long-term-care reserves and $104 million of merger-related costs. In 2015, results included a $270 million gain on the Concentra sale and a $176 million premium-deficiency reserve for 2016 individual commercial coverage. Excluding these items, management attributed the year-over-year improvement in pretax performance primarily to individual Medicare Advantage, Healthcare Services and state-based Medicaid; the filing does not provide a single adjusted earnings figure.
At December 31, cash and investments were $13.675 billion, total assets $25.396 billion, debt $4.092 billion and stockholders’ equity $10.685 billion. Cash and cash equivalents were $3.877 billion; benefits payable were $4.563 billion. Humana reported $300 million of commercial paper outstanding and no revolver borrowings, with $1 billion of capacity under its revolving credit agreement. Management said available liquidity was adequate for at least the next 12 months. Operating cash flow benefited from working-capital timing and should not be assumed to represent recurring earnings growth.
Material changes versus 2015
- Medicare premiums and enrollment remained central to growth: individual Medicare Advantage membership rose 3.1% to 2.838 million and stand-alone PDP membership rose 8.6% to 4.951 million. Group Medicare Advantage membership fell 26.6%, primarily after a large account moved to a private exchange.
- Individual commercial medical membership declined 27.2% to 654,800 amid claims volatility, weaker competitiveness and product withdrawals. Premiums for the segment fell 22.2% to $3.064 billion.
- Healthcare Services pretax income increased 8.8% to $1.067 billion, primarily on pharmacy growth, partly offset by lower Medicare rates affecting provider services.
- Services revenue fell 31.1%, primarily reflecting the 2015 sale of Concentra. Investment income fell 17.9% to $389 million, mainly due to lower realized gains and interest rates.
- Operating cash flow rose to $1.936 billion from $868 million, while cash and cash equivalents increased to $3.877 billion from $2.571 billion.
Outlook, risks and unusual items
- Aetna merger: A court permanently enjoined the proposed merger on January 23, 2017; Humana and Aetna mutually terminated the agreement on February 14. Humana is entitled to a $1 billion breakup fee. The company cited transaction costs, diverted management attention and potential business disruption. It authorized up to $2.25 billion in share repurchases and expected a $1.5 billion accelerated repurchase in first-quarter 2017.
- Individual commercial exit: Humana announced it would exit individual commercial medical coverage effective January 1, 2018, citing further signs of an unbalanced exchange risk pool. It expected 2017 premiums from compliant offerings of $850–$900 million, versus $3.3 billion in 2016; 2017 coverage was reduced to 11 exchange states and substantially all compliant off-exchange plans were discontinued.
- Medicare Advantage quality ratings: The share of July 2016 MA membership in plans rated four stars or higher for the 2018 bonus year declined to approximately 37%, from 78% the prior year. Humana sought reconsideration and planned operational and contract actions. Management said the change was not expected to materially affect 2017 Medicare revenue but could materially affect 2018 revenue.
- Management’s 2017 outlook: Expected net membership growth of 30,000–40,000 in individual MA, 70,000–80,000 in group MA and 320,000–340,000 in stand-alone PDP. The expected effective tax rate was approximately 36%–37%, primarily reflecting the one-year 2017 suspension of the health insurer fee.
- Long-term care: The $505 million reserve strengthening reflected longer claims duration, persistently low interest rates and increased life expectancy. The closed block’s future policy benefits were $2.2 billion at year-end; management estimated further adverse assumption changes could add up to $250 million in reserves, net of reinsurance.
- Government and regulatory exposure: Medicare, Medicaid and military programs are subject to payment, audit and contract risks. CMS risk-adjustment audits and the transition to encounter-data scoring could affect payments. The TRICARE East award was subject to protests. A potential Penn Treaty guaranty-fund assessment was estimated at approximately $30 million.
- Other risks: The filing highlights medical-cost and claims-reserve estimation uncertainty, provider contracting, health-care reform and exchange settlements, litigation and investigations (including Medicare risk-adjustment matters), cybersecurity and privacy, and dependence on regulated subsidiary dividends. The health insurer fee was $916 million in 2016 and is scheduled to resume in 2018.
Important facts for investors to verify
- Whether the $1 billion Aetna termination fee was received, and how it was recognized in subsequent-period results and cash flows.
- The actual 2017 and 2018 effects of the exchange exit, including run-off costs, membership attrition and any remaining risk-adjustment or reinsurance settlements; reconcile the risk-corridor write-off with any amounts still claimed or collectible.
- Whether MA star-rating reconsideration or operational changes mitigate the potential 2018 revenue and membership impact.
- Whether long-term-care claims, rate approvals and investment yields require further reserve increases beyond the 2016 strengthening.
- Medical claims reserve adequacy and the sustainability of favorable prior-year reserve development, which was $582 million in 2016.
- Resolution and financial impact of CMS audits, the Florida-related Medicare risk-adjustment investigations, TRICARE contract protests and other contingencies.
- Humana reported effective disclosure controls and internal control over financial reporting; its independent auditor issued an unqualified opinion on the financial statements and internal controls.