Humana Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are with December 31, 2013. The interim financial statements are unaudited. Humana operates Retail, Employer Group and Healthcare Services segments, with Medicare products central to its business.
Financial performance
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Total revenue | $11.712 billion | $10.486 billion; up 11.7% |
| Net income | $368 million | $473 million; down 22.2% |
| Diluted EPS | $2.35 | $2.95; down 20.3% |
| Operating income | $721 million | $765 million |
| Benefit ratio | 82.3% | 83.0%; improved 0.7 percentage points |
| Operating cost ratio | 15.4% | 13.9%; increased 1.5 percentage points |
| Effective tax rate | 46.4% | 35.2% |
Premiums rose 12.3% to $11.083 billion, primarily on Medicare Advantage, Medicare prescription-drug-plan and individual commercial membership growth. Benefits expense increased 11.3% to $9.124 billion, while operating costs rose 23.4% to $1.785 billion. The higher costs included the health-insurer fee, new-member acquisition costs and investment in exchanges and new state contracts. Favorable prior-year medical-claims reserve development was $297 million, versus $266 million a year earlier.
Operating cash flow was $671 million, compared with $412 million in Q1 2013; investing cash flow was negative $171 million and financing cash flow was positive $24 million. Cash and cash equivalents were $1.662 billion at quarter-end, up from $1.138 billion at year-end. Capital expenditures were $106 million in the quarter. Long-term debt was $2.598 billion; the company reported no borrowings under its $1.0 billion revolving credit agreement and $995 million of remaining borrowing capacity. Stockholders’ equity was $9.725 billion.
Material changes and segment developments
- Retail: Pretax income fell 25.1% to $262 million. Lower Medicare stand-alone prescription-drug-plan results, including higher costs from a new Hepatitis C treatment, and investment spending weighed on results. Individual Medicare Advantage membership grew 15.8% year over year; stand-alone PDP membership grew 20.3%; individual commercial medical membership grew 52.1%.
- Employer Group: Pretax income increased 6.6% to $226 million, supported by a lower benefit ratio, partly offset by higher operating costs. Group Medicare Advantage membership increased 15.7%.
- Healthcare Services: Pretax income rose 56.8% to $185 million, primarily from pharmacy and home-based services growth serving the larger Medicare Advantage population.
- Other Businesses: Pretax income declined to $25 million from $58 million, primarily because the prior-year period included a favorable Department of Defense contract-claims settlement. Puerto Rico Medicaid coverage had ended in September 2013.
Outlook, risks and unusual items
- Management expected full-year 2014 operating cash flow to decline from 2013. It cited timing of working capital and expected 2014 commercial risk-program receivables and Medicare Part D subsidy balances to be settled in 2015; these could materially affect cash flow.
- Humana expected to pay approximately $548 million for the 2014 health-insurance industry fee in September. Approximately $137 million was recognized as Q1 operating-cost expense. The nondeductible fee raised the Q1 effective tax rate by about 9 percentage points; management estimated a 2014 effective tax rate of approximately 46%–47%.
- Management estimated 2015 Medicare Advantage funding cuts of approximately 2% based on the final rate notice and other payment factors. It said it believed it could design competitive products, while warning that failure to do so could materially harm results.
- Management forecast 2014 capital expenditures, excluding acquisitions, of approximately $525 million to $575 million. It also cited higher-than-bid Hepatitis C drug costs and related subsidy receivables as a source of cash-flow timing risk.
- Risks include Medicare payment and quality-bonus changes, sequestration-related provider disputes, uncertainty in Health Care Reform risk-sharing settlements, and regulatory and legal proceedings. A Medicare Advantage risk-adjustment audit was pending; the company said its estimated settlements were not material but could not determine whether the audits might ultimately have a material adverse effect. For specified legal matters, Humana said it could not estimate possible losses beyond accruals, if any, and outcomes could be substantial.
- The company reported a Florida qui tam appeal and continuing government information requests concerning matters including provider coding. Its risk-factor disclosure also highlighted the delayed ICD-10 implementation, then scheduled for no earlier than October 1, 2015, and potential claims-processing, coding and risk-adjustment impacts.
Most important facts for investors to verify
- Whether Medicare Advantage and PDP membership growth translates into sustainable margins, particularly amid funding changes and higher specialty-drug costs.
- Actual timing and amounts of commercial risk-program and Medicare Part D subsidy settlements, and the resulting 2014 cash-flow impact.
- The health-insurer fee’s impact on expenses, taxes, regulated-subsidiary surplus and distributions to the parent.
- Developments in Medicare risk-adjustment audits, Florida investigations and litigation, provider disputes, and related loss accruals.
- Execution against the stated 2014 capital-spending outlook and management’s expectation of lower operating cash flow than in 2013.