Humana Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited. Comparisons are with Q1 2011 unless stated otherwise. Humana provides health insurance and health and wellness services, with major businesses in Medicare, employer group plans, and health services.
Financial performance and liquidity
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $10.219 billion | $9.191 billion | Up 11.2% |
| Benefits expense | $8.350 billion | $7.345 billion | Up 13.7% |
| Operating income | $416 million | $524 million | Down 20.6% |
| Net income | $248 million | $315 million | Down 21.3% |
| Diluted EPS | $1.49 | $1.86 | Down 19.9% |
| Benefit ratio | 85.4% | 83.8% | Up 1.6 percentage points |
| Operating cost ratio | 13.7% | 13.8% | Down 0.1 percentage point |
| Operating cash flow | $2.346 billion | $796 million | Up $1.550 billion |
Premiums rose 11.5% to $9.775 billion, chiefly reflecting Medicare membership growth. The higher benefit ratio and operating costs more than offset revenue growth. Management noted favorable prior-period claims reserve development was only about $8 million, or $0.03 per diluted share, versus $84 million, or $0.31 per diluted share, in Q1 2011; the comparison also included an extra day of claims in leap-year 2012.
Cash and cash equivalents were $3.656 billion at March 31, up from $1.377 billion at year-end. The Q1 operating cash figure was substantially boosted by receipt in March of $2.0 billion of April Medicare premiums because April 1 fell on a weekend; the quarter included four monthly Medicare payments versus three a year earlier. Unearned revenues rose to $2.298 billion from $213 million. Investing cash use was $190 million and financing provided $123 million.
At March 31, total assets were $20.700 billion, current liabilities $8.823 billion, total liabilities $12.466 billion, and stockholders’ equity $8.234 billion. Long-term debt was $1.621 billion, down from $1.659 billion at year-end; the company repaid $36 million of higher-rate junior subordinated debt. The $1.0 billion revolving credit facility had no borrowings and $986 million of available capacity. Humana reported compliance with its credit covenants and stated it expected liquidity to cover operating and regulatory needs, investment, debt, dividends, and repurchases for at least 12 months.
Material changes and business developments
- Retail pretax income fell 47.0% to $115 million. Its benefit ratio increased to 87.6% from 85.8%, and its operating cost ratio rose to 10.4% from 10.0%. Retail Medicare Advantage and stand-alone Part D membership grew 18.1% and 21.7%, respectively, year over year.
- Employer Group pretax income declined 12.9% to $121 million. The benefit ratio rose to 81.6% from 78.7%, while the operating cost ratio improved to 16.3% from 18.3%. Higher group Medicare Advantage membership contributed to premium growth.
- Health and Well-Being Services pretax income increased 36.1% to $132 million, supported by pharmacy growth and higher mail-order utilization. Script volume increased approximately 19% to 58 million.
- Other Businesses pretax income decreased to $17 million from $35 million, mainly due to lower TRICARE South contract income.
- Humana acquired Arcadian effective March 31, adding approximately 62,600 Medicare Advantage members; MD Care, acquired in December 2011, added approximately 12,100. The Arcadian purchase-price allocation was preliminary. The company agreed to divest business covering approximately 12,600 members in eight areas to resolve DOJ antitrust concerns, with divestitures anticipated for January 1, 2013.
- A new five-year TRICARE South contract began April 1, 2012, after the reporting period. Unlike the expired contract, the new contract is accounted for on a net administrative-services-fee basis, with the government retaining healthcare-cost risk. Annual renewal is at the government’s option.
Outlook, risks, and unusual items
- CMS announced an average 3.07% increase in Medicare Advantage payment rates for 2013. Management said it believed it could design competitive products and continue cost-reduction and care-improvement initiatives, but cautioned that successful execution was not assured. No specific company-wide earnings guidance is provided in the supplied filing text.
- Medicare Advantage risk-adjustment data validation audits may result in payment settlements. CMS’s final methodology permits extrapolation from audit samples; Humana awaited further CMS guidance and could not determine whether audits would materially affect results.
- Humana disclosed an ongoing internal investigation into aspects of its Florida operations, voluntary reporting to regulators, a related qui tam case, and a federal request for documents concerning matters including claims coding and loans to physician practices. The company said penalties, sanctions, or litigation outcomes could be substantial; it could not estimate possible losses beyond any accruals.
- Other contingencies include provider litigation and ongoing regulatory reviews. In a separate arbitration, claimants received approximately $2.2 million net of Humana Military’s $1.1 million counterclaim recovery.
- Management highlighted uncertainties from health reform, including Medicare payment changes, minimum benefit-ratio requirements, the non-deductible insurer assessment planned from 2014, and pending legal and regulatory developments. The company said these could adversely affect pricing, enrollment, costs, margins, goodwill, and cash flows.
- For the investment portfolio, Humana reported $13 million of gross unrealized losses and no material other-than-temporary impairments. It estimated a 1% rise in interest rates would generally reduce securities’ fair value by approximately $434 million; future impairment or realized losses remained possible.
- The SeniorBridge acquisition agreement remained subject to state regulatory approval. The board raised the quarterly dividend to $0.26 per share in April and authorized a new share repurchase program of up to $1 billion, expiring June 30, 2014.
Investor facts to verify
- Whether the sharp rise in operating cash flow and cash balance reverses as the early Medicare premium receipt and working-capital timing normalize.
- Whether membership expansion can be converted into improved underwriting results, particularly given the higher benefit ratio and much lower reserve-development benefit year over year.
- The financial effects and timing of the TRICARE accounting transition, DOJ-required divestitures, and the Arcadian acquisition’s final purchase-price allocation.
- Developments in CMS risk-adjustment audits and the Florida investigations, including any potential settlements, sanctions, or other material liabilities.
- Implementation and economic effects of health-reform requirements, future Medicare rates, quality bonuses, and insurer assessments.