Humana Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; filed November 6, 2013. Interim financial statements are unaudited. Humana provides health insurance and healthcare services, with results reported in Retail, Employer Group, Healthcare Services, and Other Businesses. Segment classifications changed in 2013; comparative segment data was recast.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $10.319B | $9.651B | $31.126B | $29.569B |
| Net income | $368M | $426M | $1.261B | $1.030B |
| Diluted EPS | $2.31 | $2.62 | $7.90 | $6.27 |
| Operating income | $621M | $701M | $2.075B | $1.707B |
| Benefits expense | $8.075B | $7.467B | $24.361B | $23.469B |
| Benefit ratio | 83.3% | 82.2% | 83.2% | 83.7% |
| Operating cost ratio | 15.1% | 14.7% | 14.4% | 14.3% |
Q3 revenue rose 6.9%, but net income fell 13.6%, primarily because Retail’s benefit ratio increased. For the nine-month period, revenue increased 5.3% and net income increased 22.4%, reflecting stronger operating results across major businesses and Medicare Advantage membership growth. Per-share comparisons also benefited from fewer diluted shares following repurchases. Favorable prior-year medical claims reserve development was $66M in Q3 and $432M year to date, versus $54M and $235M, respectively, in 2012.
Cash flow and financial position: Operating cash flow was $1.732B for the first nine months, versus $1.718B in 2012; investing cash use was $1.143B and financing cash use was $640M. Cash and equivalents were $1.255B at September 30, down $51M from year-end 2012. Current and long-term investment securities totaled about $9.999B. Long-term debt was $2.603B, versus $2.611B at year-end; total liabilities were $11.297B and stockholders’ equity was $9.606B. Humana reported $994.6M of remaining capacity under its $1B revolving credit facility, no borrowings under it, and compliance with its covenants.
Capital uses included $301M of share repurchases and $125M of dividends during the nine months. Capital expenditures were $310M; management expected full-year 2013 expenditures of approximately $425M–$450M, excluding acquisitions. The quarterly dividend was raised to $0.27 per share; the Board declared the same amount for January 2014.
Material changes and operating developments
- Retail premiums increased 8.5% year to date, with Retail pretax income up 21.1%; however, Q3 Retail pretax income fell 19.1% to $338M as its benefit ratio rose to 84.1% from 82.4%. Medicare Advantage and stand-alone Part D membership increased 6.9% and 7.7%, respectively, year over year.
- Employer Group pretax income rose 36.9% year to date to $401M, supported by Medicare Advantage growth and lower benefit and operating cost ratios. Commercial ASO membership declined 5.7%.
- Healthcare Services pretax income increased 3.8% year to date to $412M. Acquisitions and growth were partly offset by planned investment in provider practices and chronic-care centers. American Eldercare was acquired in September 2013 for a business serving Florida Medicaid long-term-care members; purchase accounting was preliminary.
- Other Businesses’ year-to-date premiums declined sharply, largely reflecting the 2012 transition to the current TRICARE South contract, which is accounted for on an administrative-services basis rather than gross premiums and benefits. The current contract’s temporary payment disruption during the federal shutdown was resolved after funding resumed.
- Puerto Rico elected not to renew three Medicaid regional contracts; coverage transition ran through September 30, 2013, with residual claims processing continuing afterward. Humana also reported costs related to the contract loss.
Outlook, risks, and contingencies
- Management estimated 2014 Medicare Advantage benchmark payment rates would decline 2.8% in aggregate; certain key markets faced estimated mid- to upper-single-digit reductions. Including the health-insurance industry fee, Humana anticipated addressing government funding reductions exceeding 4% in aggregate. Sequestration had reduced Medicare Advantage and Part D payments by 2% beginning April 1, 2013.
- Management said it believed it could design competitive Medicare Advantage offerings despite funding reductions, but cautioned that execution was uncertain. CMS’s October 2013 ratings placed 55%–60% of Humana Medicare Advantage members in plans rated at least four stars; four stars would be required for bonus payments beginning in 2015, compared with the broader eligibility in 2014.
- Humana expected the non-deductible health-insurance industry fee beginning in 2014 to significantly increase its effective tax rate. Regulatory treatment could also restrict subsidiary surplus and reduce dividends to the parent.
- Exchange enrollment began October 1, 2013, with Humana expecting offerings in metropolitan areas in 14 states. The filing identifies website functionality, enrollment mix, adverse selection, and the adequacy of risk-adjustment, reinsurance, and risk-corridor mechanisms as uncertainties.
- CMS selected certain Medicare Advantage contracts for 2011 risk-adjustment data validation audits. Humana said it was awaiting benchmark guidance and could not determine whether the audits would materially affect results. Potential litigation and regulatory outcomes, including provider disputes over sequestration adjustments and a Florida qui tam matter, were also uncertain; the filing did not provide a clear estimate of possible losses beyond accruals.
- Investment portfolio unrealized gains declined substantially during the period. Management attributed unrealized losses primarily to higher interest rates and tighter liquidity and reported no material other-than-temporary impairments. It estimated a 1% rate increase could reduce fixed-income portfolio fair value by approximately $461M.
Important facts for investors to verify
- Whether elevated favorable prior-year claims reserve development is repeatable and how underlying medical cost trends affect future benefit ratios.
- Actual 2014 Medicare payment-rate impacts, star ratings and bonus eligibility, and the ability to preserve margins while retaining membership.
- Financial and operational effects of exchange enrollment, ACA fees, Medicaid contract transitions, and new state-based contracts.
- Results and potential exposure from RADV audits, provider sequestration disputes, and other legal or regulatory matters.
- Acquisition performance and integration costs, particularly for American Eldercare and previously acquired healthcare-services businesses.
- Investment valuation sensitivity, cash generation, regulated-subsidiary dividend capacity, and capital allocation including share repurchases and dividends.