Business context and reporting period
Anthem, Inc. (the historical registrant; identified as Elevance Health in the request metadata) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. Anthem provided health benefits and related services and reported 39.9 million medical members, up 3.1% year over year. Its reportable segments were Commercial and Specialty, Government, and Other. Unless otherwise noted, dollar amounts below are in millions.
Financial performance and condition
- Revenue: Third-quarter operating revenue was $21,125, up 6.8%; total revenue, including investment income and investment gains and losses, was $21,404, up 7.5%. Nine-month operating revenue was $62,709, up 7.4%; total revenue was $63,149, up 7.1%.
- Profit and EPS: Third-quarter net income was $618, down 5.7%, and diluted EPS was $2.30, down 5.3%. Nine-month net income was $2,101, down 11.7%, and diluted EPS was $7.84, down 9.5%.
- Margins and claims: The benefit expense ratio rose to 85.5% from 83.6% in Q3 and to 83.9% from 82.0% for nine months. The SG&A ratio improved to 14.8% from 15.6% in Q3 and 15.9% for nine months. Net income as a share of total revenue fell to 2.9% from 3.3% in Q3 and to 3.3% from 4.0% for nine months.
- Cash flow: Nine-month operating cash flow was $2,930, down from $3,167. Investing used $1,185 and financing used $1,314. Cash and cash equivalents ended the period at $2,546, up from $2,114 at year-end 2015.
- Liquidity and debt: Cash, cash equivalents and investments, including long-term investments, totaled $24,985. Parent-company cash and investments available for general corporate use were $2,072. The reported debt-to-capital ratio was 38.7%, versus 40.8% at December 31, 2015. Total assets were $64,400 and shareholders’ equity was $24,744.
- Capital returns: Dividends were $0.65 per share in Q3, versus $0.625 a year earlier. No shares were repurchased under the repurchase program during the first nine months of 2016.
Material changes versus comparable periods
- Revenue growth reflected premium rate increases, Medicaid membership expansion, growth in ACA-compliant individual products, and higher self-funded administrative fees. Medical membership increased by 1.2 million; Medicaid membership rose 9.4% and Government segment membership rose 6.2%.
- Government Business revenue grew 10.9% in Q3 and 11.4% over nine months, but operating gain fell 23.6% and 19.6%, respectively. Management attributed the pressure to Medicaid medical costs exceeding rate adjustments, including higher-than-expected experience in Iowa, a market entered in 2016.
- Commercial and Specialty operating gain increased 3.0% in Q3 and 7.4% for nine months. Lower expense ratios and favorable risk-adjustment accrual adjustments helped, partly offset by higher Individual medical costs.
- Higher claims payments and membership growth contributed to lower operating cash flow. Nine-month investment impairment losses recognized in income increased to $104 from $55; realized financial-instrument results shifted to a $24 loss from a $127 gain, largely reflecting derivative losses. In Q3, however, realized results improved to an $89 gain from an $12 loss.
- Higher interest expense, including amortization of fees for Cigna acquisition financing commitments, and acquisition-related costs weighed on nine-month earnings. Higher taxes and lower Government results contributed to the Q3 net-income decline.
Outlook, commentary, risks and unusual items
- Management estimated 2016 cost-of-care trend of 7.0%–7.5% for Local Group fully insured business only. It reported consistent outpatient and professional utilization, lower inpatient and pharmacy utilization, and provider rate increases as a key cost driver. No consolidated earnings or EPS guidance is stated in the filing text.
- Pending Cigna acquisition: The proposed transaction was valued at approximately $53 billion, subject to closing-price adjustment, and was to be funded with cash and new debt. DOJ and certain state attorneys general sued to block it; trial was expected to begin November 21, 2016. The agreement contemplated closing by January 31, 2017, extendable to April 30, 2017 under specified conditions. Anthem estimated pro forma debt-to-capital of about 49% after closing and targeted the low-40% range roughly 24 months later. A termination under certain regulatory circumstances could require a $1,850 termination fee. These are forward-looking estimates, not completed outcomes.
- Legal and operational exposures: Anthem sued pharmacy-benefit manager Express Scripts, alleging pricing above competitive benchmarks and operational breaches; its claimed pricing damages were approximately $13 billion over the remaining agreement term and $1.8 billion for the transition period, plus more than $158 in operational damages. Express Scripts disputed the claims and asserted counterclaims. The company also disclosed ongoing litigation related to its 2015 cyberattack; it could not reasonably estimate related possible losses and expected further remediation expenses.
- For other specified legal proceedings where losses were reasonably possible and estimable, Anthem reported an aggregate range of $0–$250 in excess of established reserves. It cautioned that many individual matters could not be estimated. A potential Penn Treaty insurer liquidation could lead to future guaranty-fund assessments; net exposure was not estimable.
- Medical claims reserves involved significant judgment. Anthem recorded $773 of favorable prior-year claims development for the first nine months, versus $818 a year earlier. Management identified claims trend and completion factors as key assumptions.
- Cash-flow hedges and financing-related derivatives were notable: Anthem paid $832 upon expiration of swaps during Q3 and reported $554 of net unrecognized cash-flow-hedge losses in accumulated other comprehensive loss. It estimated that hedge amortization would add about $19 to interest expense over the following 12 months.
- Management said the company had sufficient resources for operations and commitments, while noting potential effects from health-care regulation, medical-cost trends, acquisition approval and integration, credit-rating downgrades, litigation, cyber risk, and restrictions on subsidiary distributions. Rating agencies had placed certain ratings under review following the merger announcement.
Key facts for investors to verify
- Whether the proposed Cigna acquisition received approvals, closed, or triggered financing, dilution, leverage, or termination-fee consequences.
- Whether Government segment medical-cost experience, particularly Medicaid and Iowa, improved relative to premium rate adjustments.
- How claims reserve development and the medical claims payable estimate changed in subsequent filings.
- The outcome and financial impact of the Express Scripts dispute, cyberattack-related litigation and investigations, and other disclosed proceedings.
- Whether operating cash flow, benefit expense ratios, investment losses, and acquisition-related interest costs developed as management expected.