HUM

Business Context and Reporting Period

Company: Humana Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Overview: Humana is a major health and supplemental benefits provider operating in two segments: Government (Medicare, Military, Medicaid) and Commercial (employer groups and individuals). As of year-end 2007, the company served approximately 11.5 million medical members and 6.8 million specialty product members. Government contracts accounted for 71% of total premiums and administrative services fees (ASO) for the year.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 17.9% to $25.29 billion, driven primarily by a 24.8% increase in Government segment premiums due to higher Medicare membership.
• Earnings Surge: Net income rose 69% to $833.7 million. Diluted earnings per share increased from $2.90 to $4.91.
• Membership Expansion: Medicare Advantage membership grew 14.0% to 1.14 million. Total medical membership increased 1.7% to 11.47 million.
• Acquisitions: The company acquired CompBenefits Corporation (dental/vision) and KMG America Corporation (supplemental health/life) in late 2007, significantly expanding specialty product offerings.
• Cash Flow Decline: Operating cash flows decreased $462.4 million to $1.22 billion, primarily due to a $725.5 million payment to CMS related to the 2006 Medicare Part D risk corridor reconciliation.
• Efficiency Gains: The consolidated benefits ratio improved by 100 basis points to 83.0%, and the SG&A expense ratio improved by 40 basis points to 13.9%.

Guidance, Outlook, and Risks

• 2008 Outlook: Management expects Medicare Advantage membership to grow by 200,000 to 250,000 members in 2008. The consolidated SG&A expense ratio is projected to range between 13.5% and 14.0% for 2008. The effective tax rate is expected to be between 35.5% and 36.0%.
• Government Contract Risks: Approximately 74% of revenue is derived from government programs. Key risks include changes in CMS payment methodologies (risk adjustment models), potential reductions in premium payments, and the renewal of the TRICARE South Region contract (expires March 2009).
• Regulatory Environment: The company faces substantial federal and state regulation regarding benefit offerings, rate setting, and marketing practices. Changes in legislation could materially affect profitability.
• Medical Cost Inflation: Profitability is sensitive to the ability to accurately estimate benefit costs. Factors such as new technologies, prescription drug costs, and an aging population drive medical cost inflation.
• Capital Requirements: Due to anticipated premium growth, the company expects to fund increased statutory capital requirements in subsidiaries with approximately $200 million in capital contributions from the parent company in 2008.

Investor Verification Checklist

• Medicare Part D Reconciliation: Verify the impact of the $725.5 million risk corridor payment made in 2007 and the estimated $102.6 million liability for 2007 settlements payable in 2008.
• TRICARE Contract Renewal: Monitor the status of the formal request for proposal (RFP) for new TRICARE contracts scheduled to begin in 2009, as the current contract is subject to annual renewal options.
• Acquisition Integration: Assess the financial performance and integration progress of CompBenefits and KMG America, which were acquired in Q4 2007.
• Benefits Ratio Trends: Track the benefits ratio for the Government segment, which is heavily influenced by the timing of Medicare Part D benefit stages and membership mix.
• Regulatory Capital: Confirm that state-regulated subsidiaries maintain statutory capital and surplus above required levels, particularly given the projected $200 million capital injection for 2008.