HUM

Business Context and Reporting Period

Company: Humana Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2004
Business Overview: Humana is a major publicly traded health benefits company headquartered in Louisville, Kentucky. It operates through two primary segments: Commercial (employer groups and individuals) and Government (Medicare Advantage, Medicaid, and TRICARE). As of year-end 2004, the company served approximately 7.0 million medical members and 1.7 million specialty product members. Government contracts accounted for 43% of total premiums and administrative services fees.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 7.2% to $13.1 billion, driven by the April 2004 acquisition of Ochsner Health Plan and increased per-member premiums in Medicare Advantage and fully insured commercial lines.
• Profitability: Net income rose 22.3% to $280.0 million. Pretax income for the Government segment increased 22.4% to $273.8 million, while the Commercial segment increased 17.4% to $142.0 million.
• Expense Ratios: The Medical Expense Ratio (MER) increased 60 basis points to 84.1%, primarily due to underwriting losses in a large commercial account and competitive pricing pressures. Conversely, the SG&A expense ratio improved by 90 basis points to 14.5% due to operational efficiencies and revenue growth outpacing administrative cost inflation.
• Cash Flow: Operating cash flow decreased to $347.8 million from $413.1 million, largely due to the timing of Medicare Advantage premium remittances (receiving 11 payments in 2004 vs. 12 in 2003 due to holiday scheduling).
• Membership: Total medical membership grew 3.9% to 7.03 million. Commercial ASO membership surged 43.0%, while fully insured commercial membership declined 2.8% due to the lapse of underperforming large group accounts.

Guidance, Outlook, and Risks

• 2005 Outlook: Management expects fully insured commercial per-member premiums to increase 6.5% to 8.5%. Medicare Advantage enrollment is projected to grow organically by 10% to 15%, with total enrollment expected to reach 470,000 to 485,000 by year-end 2005 (including the February 2005 acquisition of CarePlus Health Plans of Florida). The consolidated SG&A expense ratio is expected to range between 13.5% and 14.5%.
• Acquisitions: On February 16, 2005, Humana acquired CarePlus Health Plans of Florida for approximately $450 million, adding 50,000 Medicare Advantage members. The transaction was financed with cash and $294 million in borrowings under the company's credit agreement.
• Key Risks:
  • Medical Cost Inflation: Rising costs for prescription drugs, hospital services, and new technologies could outpace premium increases.
  • Government Contract Dependency: 43% of revenue comes from government contracts (TRICARE, Medicare, Medicaid). Changes in reimbursement rates or legislative action (e.g., Medicare Modernization Act) pose significant risks.
  • Legal Proceedings: The company is a defendant in In re Managed Care Litigation, a class action suit alleging improper claim payments and "downcoding." Trial is scheduled for September 2005.
  • Regulatory Compliance: Subject to extensive federal and state regulations, including audits and the Corporate Integrity Agreement with the Office of Inspector General.

Investor Verification Checklist

• Verify the impact of the TRICARE contract transition on 2005 revenue stability, as the company moved from Regions 2/5 to the new South Region contract.
• Monitor the Medical Expense Ratio (MER) trend, specifically the 100 basis point increase in the Commercial segment, to ensure it does not widen further due to competitive pricing.
• Review the status of the managed care class action litigation and potential liability exposure.
• Confirm the integration and financial performance of the Ochsner Health Plan acquisition and the subsequent CarePlus Health Plans acquisition.
• Assess the company's ability to maintain its investment-grade credit rating (Baa3/BBB) given the $294 million in new borrowings for the CarePlus acquisition.