Humana Inc. — Q1 2013 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2013, compared with Q1 2012. Humana is a health insurer and healthcare services provider; Medicare products generated approximately 74% of premiums and services revenue. Segment presentation was reorganized in 2013, with prior-period segment data recast. The new TRICARE South contract, effective April 1, 2012, is accounted for like an administrative-services arrangement rather than on a fully insured basis, materially affecting year-over-year comparisons.
Financial performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $10.486 billion | $10.219 billion | +2.6% |
| Premium revenue | $9.868 billion | $9.775 billion | +1.0% |
| Services revenue | $525 million | $350 million | +50.0% |
| Operating income | $765 million | $416 million | +83.9% |
| Net income | $473 million | $248 million | +90.7% |
| Diluted EPS | $2.95 | $1.49 | +98.0% |
| Benefit ratio | 83.0% | 85.4% | Down 2.4 percentage points |
| Operating cost ratio | 13.9% | 13.7% | Up 0.2 percentage points |
| Effective tax rate | 35.2% | 36.5% | Down 1.3 percentage points |
Management attributed stronger earnings mainly to lower benefit ratios in Retail and Employer Group and improved Retail and Employer Group operating-cost efficiency. Favorable prior-year medical-claims reserve development was $266 million, versus $141 million a year earlier. Q1 2013 results also included a favorable Department of Defense contract-claims settlement; management said it benefited diluted EPS by $0.19.
Segment pretax income: Retail was $350 million, up from $128 million; Employer Group was $205 million, up from $129 million; Healthcare Services was $125 million, unchanged; and Other Businesses was $58 million, versus $5 million. The DoD settlement contributed to the Other Businesses improvement. Healthcare Services growth, including acquisitions, was offset in part by investment in the integrated-care model.
Cash flow, balance sheet and liquidity
- Operating cash flow was $412 million, versus $2.346 billion in Q1 2012. The prior-year quarter included an early $2.0 billion Medicare premium receipt for April, making the comparison unusually large; Q1 2013 operating cash flow also reflected working-capital movements, including a $588 million increase in receivables.
- Investing cash outflow was $392 million; financing cash inflow was $72 million. Cash and cash equivalents rose to $1.398 billion from $1.306 billion at year-end 2012.
- At March 31, 2013, total assets were $20.974 billion, total liabilities $11.810 billion, and stockholders’ equity $9.164 billion. Current assets were $12.678 billion and current liabilities $6.944 billion.
- Long-term debt was $2.608 billion, approximately unchanged from year-end. The company had no borrowings under its $1.0 billion revolving credit agreement and reported $995 million of remaining capacity. It was in compliance with covenants; agreement-defined leverage was 0.9:1 against a 3.0:1 maximum.
- Investment securities totaled $9.965 billion at fair value; about 94% of debt securities were investment grade. The portfolio’s average duration, including cash equivalents, was 4.2 years. Management estimated a 1% interest-rate increase would reduce securities’ fair value by approximately $465 million.
- Capital returned included $81 million of open-market share repurchases and $42 million of dividends paid. The Board later declared a $0.27-per-share dividend and authorized up to $1 billion of repurchases through June 30, 2015.
Material changes and outlook
- Retail and Employer Group benefit ratios each declined 1.6 percentage points year over year, to 85.9% and 79.6%, respectively. Management cited favorable reserve development, lower claims trends, and weekday seasonality, including one additional claims day in leap-year 2012.
- Individual Medicare Advantage membership increased 6.8% year over year to 2.012 million; standalone Medicare Part D membership increased 8.9% to 3.202 million. Total Retail medical membership grew 8.5% to 5.836 million.
- Services revenue rose partly because the new TRICARE contract is reported as services revenue, while its predecessor was reported as premiums and benefits. The transition reduced reported Other Businesses premiums and benefits and limits direct comparability.
- Management estimated that 2014 Medicare Advantage bid benchmark payment rates would decline 2.8% in aggregate, including risk-coding recalibration and county rebasing. It anticipated addressing government funding reductions of more than 4% in aggregate when including the health-insurance industry fee. Management believed competitive products could be designed, but warned execution was not assured. The filing provides no specific full-year earnings guidance.
- Management said cash, investments, operating cash flow and available financing were sufficient for operating and regulatory needs, capital spending, acquisitions and other planned uses for at least the next 12 months. Expected 2013 capital expenditures, excluding acquisitions, were approximately $425 million to $450 million.
Risks, contingencies and unusual items
- CMS Medicare Advantage risk-adjustment data validation audits may produce extrapolated settlements. Humana’s internal estimates for 2011–2013 were not material, but it was awaiting benchmark audit data and contract selections and could not determine whether audits might have a material adverse effect.
- Regulatory reviews and litigation remain ongoing. A Florida qui tam case alleging improper member incentives and related Medicare claims was dismissed with prejudice, and reconsideration was denied; an appeal deadline remained pending. A U.S. Attorney’s Office was also seeking information about certain South Florida provider coding and physician-practice loans. The filing says outcomes and any losses beyond accrued amounts could not be estimated and could be material.
- Humana cited potential effects of healthcare reform, including Medicare payment reductions, the non-deductible industry fee, benefit-ratio requirements, exchange implementation and regulatory uncertainty. These could affect pricing, enrollment, costs, margins and cash flows.
- Unrealized investment losses were $13 million; management considered them temporary and reported no material other-than-temporary impairments. It cautioned that future market declines could lead to realized losses or impairments.
- The Puerto Rico Medicaid contracts were due to expire June 30, 2013, and the company was negotiating a one-year extension. The TRICARE contract had been extended through March 31, 2014. Loss or adverse changes to government contracts could materially affect results.
Investor verification priorities
- Separate recurring performance from the $266 million favorable prior-period claims reserve development and the DoD settlement benefit.
- Assess the 2014 Medicare payment-rate and industry-fee assumptions, and whether Humana can preserve benefits, membership and margins while responding.
- Track CMS risk-adjustment audits, benchmark methodology and any resulting settlement exposure.
- Monitor operating cash conversion and receivables, especially Medicare risk-adjustment balances and the timing effects that distort year-over-year cash-flow comparisons.
- Review government-contract renewals, regulatory proceedings and litigation developments, including Puerto Rico Medicaid and TRICARE.